Five common investing mistakes to avoid

Russell Investments recently posted a list of companies joining and leaving the Russell 3000 index on June 25. In anticipation of this event, many investors have either bought the stocks of companies being added to the index or sold those being deleted from it. Big mistake.

In fact, it might be better to do the exact opposite, because stocks deleted from an index tend to have significantly higher factor-adjusted returns than index additions, and stocks added to an index have "poor long-term returns," according to a study published in the Financial Analysts Journal in 2008 by Jie Cai, an assistant professor of finance at Drexel University, and Todd Houge, a chartered financial analyst and professor of finance at the University of Iowa.

1. Don't sell stocks deleted from an index, or buy stocks added to an index

The Russell 3000 index represents about 98% of the investable U.S. equity universe, and on June 25 about 261 companies will be added to the index and about 205 companies will be deleted from it.

That fact alone shouldn't prompt investors to make buy or sell decisions, said David Zuckerman, a certified investment management analyst and chief investment officer of Zuckerman Capital Management LLC.
"For investors who own stocks that will be deleted from an index, the empirical data indicates that they should not sell their holdings," he said.

"Buying stocks that will be added to an index ahead of reconstitution is not a viable investment strategy, and the data suggest that returns may suffer if such a strategy is followed," he said. "Ultimately, decisions to buy and sell stock should be based on fundamentals and not on index reconstitution."

Buying companies based on an index's reconstitution is just one of four common mistakes investors make.

2. Don't buy stocks before ex-dividend date

According to Zuckerman, another mistake investors make is buying stocks before their ex-dividend date, and then selling them shortly after the dividend is paid.

"This is a flawed strategy as stocks will often experience a decline in price that is proportional to the dividend distribution," he said. "The idea that simply buying stocks ahead of a dividend distribution can generate outsize profits is preposterous."

3. Chasing returns

Wall Street has taken a page from Madison Avenue and it's to the detriment of average investors.

"As a result of the marketing creativity of the financial services industry, the typical investor has been conditioned to concentrate on day-to-day market noise and relative performance," said Andrew P. Mehalko, chief investment officer at GenSpring Family Offices. "The result of this approach leads unassuming investors to focus on trading and actively moving assets from product-to-product or manager-to-manager; in effect, 'chasing returns.'"

4. The case of too many or too few

Mehalko says another mistake investors commonly make is a concept that he calls "disworsification." That's the choosing of many holdings, most of which are highly correlated. As a result the portfolio is "not able to provide true diversification," he said.

Investing in too many similar things is a problem. So too is investing too much in one thing, according to Michael Stillman, an accredited investment fiduciary with Cloud Capital.

"Investing in one single mutual fund for a specific investment style or asset class," he said. "This is a dangerous approach because fund managers can be like baseball players. They have hitting slumps and streaks. A single fund could put you in a vulnerable position if that fund manager is just coming off a hot streak and begins to underperform. It's better to spread your investment around in at least two or three similar funds so that you don't end up firing an asset class by mistake."

5. Forgetting why you bought in the first place

Ben Utley, a certified financial planner with Physician Family Financial Advisors Inc., said the No. 1 mistake investors make is this: "When they're selling, they forget why they bought in the first place."

Said Utley: "When I see investors doing what I consider 'a good job' of investing, they are resolute in their reason for investing, and they sell only when that reason is no longer valid."

Take a person who buys stock in Apple because they own or love the company's products. In that case, they should sell only when they start to shop for similar products from other manufacturers. Or take the person who buys Pfizer on a family recommendation. That person should sell only when the family member recommends selling Pfizer.

"It's so simple to articulate, but so challenging to follow," Utley said. "We live in the era of constant news and financial porn. It can be tough to stick with your principles."

Source: MarketWatch