Jeff's Editorial #163 - 5 Ways to LOSE BIG money in the stock market

My opinion

Five Ways to LOSE BIG money in the stock market

Read my previous post “6 Ways to LOSE BIG money” post first.

In the last 5 years we have come to realize that earning and keeping money in your account is becoming a difficult task.  We have realized that companies are constantly pulling dollar here and dollar there out of our wallets, and they are succeeding. In the investment arena, investors are unsure if their money is ever going to make any money now or in the future.

At the end of the day, what most consumers want is to have a comfortable amount in their investments so that they can live in relative comfort when they retire.  Some are succeeding in the stock market where most people are investing their retirement savings, but some are definitely not.

I will offer my opinions on what some are doing in their investments, perhaps unconsciously, to allow their nest egg to shrink over their lifetime because they make a small but devastating mistakes when and while they invest their hard-earned money.  Many of these ideas are borrowed from my previous post “6 Ways to LOSE BIG money”

Let me list five notable ways to LOSE BIG MONEY:

1. Not following these common sense investment rules:
   1. Buy low; sell high – Don’t get caught up in the emotion of the moment.  Follow your set rules like: buy when the stock reaches certain point, or sell when the news is good.
   2. Don’t put a lot in one basket – Remember the Enron and WorldCom.  When everybody is telling you to buy, be skeptical.  Keep a 10-foot pole close by, and ask: “What if something goes wrong and my portfolio loses 20% in one day?  Can I live with the consequence?”  Understand your risk tolerance, and be proactive about thinking multiple outcomes for your investment.
   3. Do your own homework – Remember that ultimately YOU are responsible for your own money that is invested.  Your financial adviser does not pay you a penny even if you lose 50% of your portfolio, even if you followed his advice explicitly.  Understand the risk of what you are investing in, and learn as much as you can BEFORE investing.  Don’t assume that your adviser knows what can happen.  He/she has no idea what tomorrow will bring.
   4. Don't follow the crowd – Just because a lot of people are waiting in a long line, whatever is found at the end of the line is not necessarily good for you.  I have a friend who took a foolish adviser's recommendation to sell his investment on March 9, 2009 (the worst day to sell stocks).  Be a contrarian if you want to be weird and rich (not normal and broke).  Look at Steve Jobs or Warren Buffet - they were not normal.
2. Not saving early and not saving enough – I can’t stress this enough.  The biggest reason for not building an adequate nest egg is that people think their nest egg will grow to a big amount by setting few percent of their income to savings.  A household with one income contributing 3% of their income to their 401(k) or IRA will be sorely disappointed when they are ready to retire.  If you start investing at age 22 and contribute 3% without a match, you will end up with $640,000 (inflated dollars) at age 65, whereas a 15% contribution will end up with $3.2 million at age 65, assuming 8% investment rate. Start contributing to your retirement fund early (as soon as you have income), and contributeat least 15% of your gross earnings.
3. Borrowing too much – If you are borrowing from your 401(k) or borrowing to invest in the stock market, you are shooting yourself in the foot.  It does not make any sense to have a home equity loan or a big credit card debt with 19.9% interest rate, while investing your money in the stock market on the other.  Pay off consumer debts and student loan BEFORE investing for retirement savings.
4. Hiring a financial adviser that charges you high fees - This is a pet peeve of mine. Some financial advisers have no compunction to charge you less than 5.75% front load, 2.0% or more expense ratio, AND a 2% adviser's fees.  By the time your retirement comes around, these fees, compounded annually, will cause you to lose millions.  Also stay away from advisor’s recommendation to take out lump sum distribution. Annualized distribution is better for your income tax because of annual deductions and personal exemptions. Avoid pushing yourself from moving upward in your tax bracket.  If you must hire a financial adviser, know the fees, charges, and what he/she can guarantee you (usually not much).
5. Not understanding income tax on investments – I have come across many folks telling me that they had to pay an exorbitant amount in income tax when they cashed out their IRA or 401(k). They should have rolled over their 401(k) or IRA into another IRA to eliminate taxes.  You should take advantage of tax laws about a year before your file this year's income tax or make a big financial move (like retirement).  Know the capital gains rules, your tax bracket, and what it could mean to your capital gains tax.  Understand that transaction timing could mean paying ordinary income tax, capital gains tax, or zero tax.

This is not a comprehensive list by any stretch of imagination.  Many other ways can cause you to lose your hard-earned money, but if you note above ways, change your bad investment habits, and start to get smart about not wasting your hard earned income.

In the near future, I plan to discuss the investment strategies:
1. Dollar cost averaging
2. Market timing
3. Buy low; sell high