Stay away from the most-risky investments on the market, including new stock issues, so you can increase your potential for profits
It’s a key tenet of our Successful Investor approach: A company using a growth-by-acquisition strategy is inherently one of the most-risky investments you can make. Newly purchased companies may develop unforeseen problems. Acquisitions in unrelated areas are especially risky in that the acquiring firm’s managers must then divide their attention among unrelated companies and industries.
Acquisitional growth can hide more unpleasant surprises than internal growth. The buyer rarely knows as much as the seller, and with repeated purchases, you’re bound to buy something with hidden problems.
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Still, small acquisitions are safer than big acquisitions because the mistakes tend to be smaller. However, they still tend to push up debt. They also load the balance sheet with goodwill—an intangible asset with value that can drop overnight if a purchase turns bad. So, you should be wary of growth by acquisition—and at the same time stick with companies that have a proven track record of integrating their buys.
Recognize that short-term trading of stocks is among the most-risky investments you can make
When investors base buy and sell decisions on short-term stock trading forecasts, they often experience notably poor investment results, or even lose money. This may come as a shock to them. In hindsight, it may seem that past market trends, up or down, should have been easy to foresee. But, in fact, nobody consistently foresees these trends. That’s why most investors hurt their returns if they let short-term market forecasts have much of an impact on their investment decisions.
Studies by the U.S.-based Dalbar organization show that if investors do a lot of in-and-out trading, they routinely make only about one-third of the return they could have earned with a simple buy-and-hold approach.
One thing to consider about short-term investing is the market’s volatility. When volatility is heightened, it makes it harder for in-and-out traders to make money.
There is no denying the immediate appeal of taking a fast profit. However, most Successful Investors find over long periods that much of their profit comes from a handful of their best investments—stocks that went up much more than they ever expected. If you are too quick to take profits, you’ll wind up selling your best picks when they are just beginning to rise.
New stock issues are also among some of the most-risky investments you can make
New stock issues (also known as IPOs or Initial Public Offerings) generally come to market when it’s a good time for investors to sell. But that’s seldom a good time for investors to buy.
We hardly ever recommend buying new issues when they are first sold to the public. For that matter, we generally stay away from new issues for months, if not years, after they first come to market. As a group, new issues under-perform the market over long periods. In addition, their results are far more variable than those of well-established stocks, and they expose you to greater risk of major loss.
Of course, many new issues do look like undervalued stocks and go up when they first hit the market. These are the “hot new issues” that everybody wants to buy. Unfortunately, hot new issues are always in short supply. Individual brokers get only a limited allotment, so they usually reserve them for their biggest and most profitable clients.
Furthermore, long-term studies show that, on average, new issues tend to do worse than comparable stocks over a variety of time periods.
Trendy investing can lead you into the most-risky investments in the market
Trend investing has natural appeal. It simplifies things. Investors like it because they feel it can put their investment returns into overdrive. Some also feel it adds fringe benefits to their investing, by letting them support social or environmental objectives.
Brokers like it because it gives them a rationale to recommend a variety of stocks.
When you focus on trend investing, however, it’s easy to overlook the fundamentals. If you’re sure gold prices are headed up, for instance, why trouble yourself with tiresome matters like finances or geology?
Stocks that are in the broker/media limelight tend to expose you to extra risk. That’s because the favourable attention they get in the limelight pushes up investor expectations. When these stocks fail to live up to those heightened expectations, and that always happens eventually, stock prices can plunge.
All trends or themes revolve around predictions. That’s the hard way to make investment decisions, and is likely to lead to expensive mistakes. That’s why we focus on well-established companies. You can spot these companies mainly by description, rather than prediction.
Many views about the future turn out to be wrong. Well-established companies are most likely to survive the inevitable setbacks and thrive all over again when good times return, as they always do.
Use our three-part Successful Investor approach and you will stay out of the most risky investments in the market
Invest mainly in well-established, dividend-paying companies;
Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; the Consumer sector; Finance; Utilities);
Downplay or avoid stocks in the broker/media limelight.
What are some of the most risky investments you’ve made, and how did they turn out?
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