How to Destroy Your Investment Portfolio

This is a guest article by Ray, the owner and primary author of Financial Highway, where he discusses investing, saving and practical money management concepts. You can check subscribe to his RSS feed or follow him on Twitter.

The past 18 months have been difficult for most investors, the stock market has seen the biggest “correction” since the great depression, “blue chip” companies have cut dividends, had massive layoffs and even begged the fed to bail them up. Not to mention the investment frauds of Bernard Madoff and Ed Earl Jones costing investors their lifetime of savings. More and more investors have decided to become “Do it Yourself” (DIY) investors and often rightly so. There really is no magic to investing; anyone can do it as long as you follow simple rules. Previously we published 10 investing tips to become a successful investor to help DIY investors. Although there is no magic to investing if you are a new DIY investor you can easily fall into the common investing traps and ruin your portfolio – detailed below.

5 Fastest ways to destroy your investment portfolio

1. Short Term Trading

This is one of the best ways to destroy your investment portfolio. With online discount brokers it is very simple to just buy and sell securities with the click of a mouse, sit in front of your monitor and constantly watch your stock price. Of course when you see your stock take a little hit just click sell and it’s sold. Thank god you acted fast and only took a 2% loss; you do that a few times a month and got your self a 10% loss. We are not even talking about fees. Statistics show that short term trading fails over the long term in overwhelmingly majority of cases. Very few people can be profitable day traders. So if you want to destroy your investment portfolio, start with short term trading.

2. Buy the “HOT” stock – Get Rich Quick

A few weeks ago a friend of mine called and said a co-worker had given him a good tip on a stock and he should buy some, he was considering a $10,000 purchase. So I asked him some basic questions: “What does the company do”, “What do analysts say”, “What’s the management’s history?”… He did not know the answer to any of these, and decided to ask the person who tipped him…he had no clue either but was sure it’s a good investment his brother-in-law’s friend had said so. I advised him against the purchase and his colleague is now down 35% in 2 weeks …OUCH! There is almost no better way to demolish your portfolio than to follow the “hot” stock tips or the get rich quick stocks. Purchasing strong, stable companies is boring!

3. Buy Exotic Investments

The investment industry loves creating new investment products, every few months some new exotic investment is brought to the market. Investors jump at these investment vehicles without understanding the risks associated with them. A great way to destroy your investment portfolio: put a large chunk of your retirement fund into these exotic investments and watch them disappear.

4. Do not have an Asset Allocation

One of the first things any investor should do before investing is have an asset allocation and stick to it, well that is for anyone who wants to see their investment portfolio grow. Asset allocation ensures you are diversified among all asset classes (stocks, bonds, cash etc). Studies show that over 90% of your portfolios variability is due to your asset allocationnot sticking to your asset allocation is crucial to the destruction of your investment portfolio.

5. Ignore Diversification

Every investor knows or has at least heard of diversification, it’s the cornerstone of every good investment portfolio. Simple concept: don’t put all your eggs in one basket. Diversifying your investment portfolio will ensure that your investments are spread out and you are not taking more risk than you need to. Just ignore this important concept and your investment portfolio will surely vanish.

You combine these five tips and you are guaranteed to lose more money in the stock market than you have ever dreamed of.

What tips do you have for those who want to demolish their investment portfolios? Any bad investment decisions you have made in the past?

Comments

  1. Studies show that over 90% of your portfolios variability is due to your asset allocation – not sticking to your asset allocation is crucial to the destruction of your investment portfolio.

    I strongly agree with the first statement — that setting your stock allocation properly is critical. I strongly disagree with the second statement — that not adjusting your stock allocation as needed to keep your risk level roughly constant makes sense.

    The idea of investing passively (not changing your stock allocation in response to changes in the valuation level of stocks) is an idea that perhaps helps The Stock-Selling Industry in the short term but that helps not one of the middle-class investors who place their confidence in the people who promoting this “idea.” Passive Investing has been tried four times in U.S. history. It has resulted in huge financial losses for all who followed it and an economic crisis for the entire country on each of those four occasions.

    When you hear an investing “expert” advocate Passive Investing, you should ask yourself — If a used car salesman told me not to look at the price of a car I was thinking of buying, would I go along? If we take into consideration the price of cars and comic books and bananas, why should we fail to do the same when buying stocks?

    Investing passively is the single biggest mistake that any investor can make. Yes, asset allocation matters. It matters enough to make it worth taking the time to look at the price at which stocks are selling before putting money on the table.

    Rob

  2. Well done, Ray. :)

    The only things I’d add would be:
    1. Ignore the expenses you’re paying, and
    2. Ignore the tax efficiency (or lack thereof) of any funds you own in taxable accounts.

  3. Good article.

    I agree that constantly changing your asset allocation is a bad idea.

    But, Rob makes some good points about passive investing. Your needs and the overall economy will change over time. You may need to adjust to meet them. Also, our allocations will sometimes get out of balance as some parts of the market do better or worse than others. Even if the overall allocations don’t change, you will need to bring them back into balance from time to time.

    If I had to add one item to your list, it would be
    this. Panic every time the market takes a downturn.

  4. Excessive trading and day trading is disasterous in the long run. Take it from a guy who’s managed to make $140,000 on a day trade on one stock, and then proceed to lose another $100,000 on the same stock being too cute.

    Don’t trade!

  5. i like the sarcasm, it drives the point home and keeps it there(lessons that i learn like this always stick). i have a a question though in the tao of buffett (warren buffett’s book- you may have heard of him, he is the richest man in the world) the says that one must not put your eggs in many baskets, put your eggs in one basket and watch that basket very closely. what do you think of this and the implications

  6. I agree with this blog entry. Just as an aside, however, the ads from google on your site were advertising to me: silver trading (with amounts you needed to invest, a potential asset allocation problem), penny stock (speculative) trading, day trading, and options trading (to most, “exotic investments”). You may want to change your google settings to block out some of these junk ads.

  7. Another problem with short term trading is you are constantly trying to time your entrance. For example I bought a stock at $8.50 that I thought was underpriced and it slowly went down to around $6. Instead of sticking to my original plan, I sold it and bought some other stocks. Horrible idea. It’s at $26 now.

    Don’t hold onto stocks in an attempt to regain losses, but also don’t sell it if you still think its undervalued!

  8. 1) Buy whatever seems to be growing and sell whatever seems to be losing value. Being 2 steps behind the herd is the best spot to be, and it smells so pleasant. Don’t pay any attention to things like P/E ratio or other measures of underlying value; those are things for the leaders of the pack to worry about.

    2) Complain that dollars are a fiat currency and buy gold, because gold is a much older and therefore magically better fiat currency, which cannot possibly ever be a bad value.

    3) Try to make a quick buck. Investing in solid assets and allowing them to grow naturally is boring.

    4) Make sure the government can tax everything twice. Things like IRAs and 401ks, which allow you to be taxed either at the start or at the end but not both, are for tax-dodging capitalist criminal pig-dogs, and you don’t want to be a TDCCP-D.

    5) If Uncle Lenny proposes a business deal, jump on it! It’s not often that you can buy into a business as stable and profitable as the one Uncle Lenny is going to build!

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