Improve your returns by avoiding these 5 common mistakes in stock market investments

Whether you’re an aggressive or more conservative investor, we feel you can improve your results in stock market investments — and cut your risk — by understanding and avoiding these 5 common investment errors:

1. Focusing on three or fewer of the 5 main economic sectors: Manufacturing and Resources stocks expose you to above-average risk, Utilities and Canadian Finance stocks involve below-average risk, and Consumer stocks fall in the middle. The sectors go in and out of investor favour, depending on economic conditions and investor whim. But in the long run, winners and losers appear in all five.

Spreading your money out across most or all of the five sectors limits the role of luck in your results. Your stock market investments will always have some exposure to the year’s most profitable investment area, and that’s a key factor in successful investing.

2. Overindulging in speculative stock market investments: Even the best speculative companies go through wider price fluctuations and expose you to greater risk than well-established stocks. If you hold too many speculative stocks, you run a far greater risk of loss during a market downturn.

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3. Buying too many “stocks that everybody likes”: Some stocks stay popular for years, if not decades. They can be very profitable during those periods. But if you invest too much of your portfolio in stocks like these, you’ll wind up getting aboard some just as they reach their peak. When these stocks fall out of favour, the drop in your returns can be breathtaking. It can also take years for such stock market investments to recover.

4. Disregarding subtle signs of high risk: These include an unusually high dividend yield or an unusually low p/e (the ratio of a stock’s price to its per-share earnings). High yields and low p/e’s are good, but only within limits.

If a stock’s yield is extraordinarily high, it usually means there is some risk that the company will have to cut or even eliminate its dividend. If the p/e is extraordinarily low, it usually means there is some risk that the company’s earnings are about to fall. Or worse, that the company is using “creative” or deceptive accounting to seem more profitable than it is.

Instead of seeking out the highest yields and lowest p/e’s, look at a wide variety of measures, rather than just one or two financial ratios.

5. Putting too much faith in trends: It pays to keep in mind that the stock market anticipates things, and no trend lasts forever. Stocks put on lengthy downturns due to business and economic problems. The downturns go into reverse long before the problems get solved.

Remember, a highly dramatized story is far more entertaining than a straight explanation of facts, and more absorbing. But don’t let entertainment value, or your degree of absorption in the story, warp your judgment.

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