The 5 Greatest Lies About Investing


We are coming to the end of two long and arduous years of investing. Along the way we have endured one of the worst selloffs and rebounds in stock market history, a systemic breakdown of the global financial system, and volatility not seen since the 1987 stock market crash. Fortunes have been made and lost. Investor confidence was shaken and very much stirred.

Very few people sold at the top in 2007 and then bought the bottom in 2009; some did manage to do one of those two things. Some bought the top and sold the bottom; most performed somewhere in between.

Now it's time to measure individual performance and prepare to move on to 2010. Naturally, we'll cling to some age-old trading and investment maxims, which are often the root of common faux pas made by bulls and bears, traders and investors, equity and fixed-income types.

Much of the following is presented in a tongue-in-cheek manner, but paying careful attention to this list also might help us to learn from our mistakes. So without further ado, here is my list of the five greatest lies of investing:

1. It Will Come Back

I can't tell you how many times one of my new clients at LakeView Asset Management will present me an existing portfolio that contains a stock with a long-term unrealized loss. When I explain to the client that we should liquidate the position, I sometimes get the response: "It will come back."

Quite often this statement is made out of emotion, nostalgia or hope. There is a chance that at some future date, Pfizer (Stock Quote: PFE) or Alcatel-Lucent (Stock Quote: ALU) will once again come back. That does not mean that we should hold on to those stocks. There are plenty of other opportunities.

2. It's a Low-Volume Rally

So many people have missed the rally in its entirety or in part since the Devil's Bottom, when the S&P 500 hit 666 in March. Here's a common excuse I hear all the time: "I did not participate because it is a low-volume rally."

Talk about rationalizing a mistake. A rally is a rally is a rally. The IRS, your bank or your family could care less if you make money in a low-volume rally or a high-volume rally. Does it matter if you score a touchdown on a five-yard run or a 95-yard pass? Both put six points up on the scoreboard. So if you spot opportunities in the market, take advantage of them. If you can't be opportunistic, then don't blame it on the volume, because whoever did produce that volume did benefit.

3. Bonds Are Safe; Stocks Are Risky

If you believe that bonds are safe and stocks are risky, then you must believe in the Easter Bunny. I have news for you: Companies can default on bonds. You can lose your entire investment in bonds. If you don't think so, ask anyone who held Lehman Brothers bonds.

Some bonds are safer than others. Some stocks are safer than others. Some stocks are safer than certain bonds. That is why we have credit ratings and credit spreads in the bond market. Furthermore, liquidity for stocks can be much better than liquidity for the same company's debt.

4. Mutual Funds and ETFs Give Me Diversified Exposure

"Diversification" is a very subjective term. You must first define what index or asset class you are diversifying against. Second, you have to worry about single stock concentration. Perhaps you don't really care. It really is a matter of choice and risk aversion, but you need to know the profile of the fund that you own.

For example, take the CGM Focus Fund (CGMFX). Its top 10 holdings represent 68.34% of the mutual fund's assets. These 10 holdings vary in weighting from 5.64% to 9.43%. There are three investment banks/money-center banks in the top 10 -- Goldman Sachs (Stock Quote: GS), JPMorgan (Stock Quote: JPM) and Morgan Stanley (Stock Quote: MS)-- totaling 21.54% of the fund. Finally, the beta of the fund relative to the S&P 500 is 1.15.

Clearly one has to wonder if this fund is diversified or if there is concentrated risk.

5. Size Matters

All too many investors confuse best-of-breed with biggest-of-breed. There is a significant difference. Jim Cramer talks about best-of-breed on "Mad Money" and writes about it in his books. Investopedia defines it as follows: "A stock that represents the most optimal investment choice for a specific sector or industry due to its high quality compared to its competitors." The biggest of breed is simply the largest company in the industry, which does not necessarily mean the best of breed, nor does the biggest in breed offer the same growth or opportunity that the best in breed does.

For example, take a look at Microsoft (Stock Quote: MSFT) and Apple (Stock Quote: AAPL). Microsoft has a market cap of $268 billion, while Apple has a market cap of $188 billion. But Apple has a five-year earnings and revenue growth track record, which far exceeds that of Microsoft. Apple is best in breed, and I prefer it for the future.

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