What Not to do When Investing Part II

This article published with permission from InvestmentU.com.

We’re in the midst of a series about how to lose more money than you ever imagined. Why? Because it’s only when an investor truly sees himself and recognizes what he’s doing is wrong that he changes his behavior, starts down the right path and reaches the end-goal: total financial independence.

So let’s start with a biggie — one that should be obvious to most investors but often isn’t. If you want to lose money, serious money, take investment advice from the wrong people.

No one does this intentionally, of course. They do it because — realizing they don’t have the time or financial expertise to handle things themselves — they want to delegate the responsibility. But to whom?

There are a lot of possibilities. You may decide to use a family member or friend. Maybe you get a referral. Maybe you deal with a big company with an established name. However, each of these choices is fraught with potential trouble.

Is a friend or family member qualified? If the person is qualified, is he or she experienced? Even if he or she is qualified and experienced, is the person ethical? Using a big Wall Street name — like Merrill Lynch or Morgan Stanley — doesn’t mean you won’t end up with god-awful advice or a rogue broker. Or both.

If you’re using any registered investment advisor, the very least you need to do is check out his or her background and disciplinary history. One way is to visit the Central Registration Depository, a computerized database that contains information about brokers, their representatives and the firms they work for. Or just pick up the phone and call the Financial Industry Regulatory Authority’s BrokerCheck Hotline at (800) 289-9999. (This may be the most important phone call you ever make.)

Perhaps you’re managing your money yourself but taking advice from various sources. This can also be risky. When I was a money manager years ago, prospective clients generally started off by showing me their existing portfolio. More often than not, they couldn’t explain what they owned or why they owned it. I called it “investment by agglomeration.” It wasn’t unusual for someone to tell me “I read about this stock in Forbes,” and “my golf partner told me about this one,” and “I’m not sure what the heck this company does.”

Good grief. This kind of undisciplined approach is virtually guaranteed to generate poor results. It’s the investment equivalent of heaving darts at the stock pages. (And a superb way to lose money.)

The investment newsletter industry isn’t above criticism either. I work with some brilliant people with impressive track records. I also work with kooky folks with nutty investment ideas. Yet a lot of smart people listen to them and act on their advice. Even when it is wrong for years … or decades even.

This puzzles me. After all, would you use a tax advisor whose clients are routinely audited or a surgeon whose patients regularly die on the table? Why, then, would you take investment advice from someone who has been dead wrong for years?

(The Dow just hit an all-time high, for instance. If you’ve been listening to someone tell you to stay out of the market the last five years, do yourself a favor and hand him a pink slip.)

You know who these people are. They tend to be bold, emphatic … and spectacularly wrong. They tell you to get completely out of stocks. Or fully invested in gold. Or highly leveraged in real estate. It doesn’t matter whether they are right from time to time.

No one has a crystal ball. Or, as historian David McCullough likes to say, “There’s no such thing as the foreseeable future.” So an all-or-nothing approach is really nothing more than advice to roll the dice with your life savings.

Anyone who isn’t telling you to spread your risk, hedge your bets and diversify along the lines of proven investment principles either isn’t qualified to give investment advice or doesn’t have your best interests at heart. Either way, you shouldn’t be listening to them, no matter how convincing or entertaining they are.

Follow these folks’ advice and you are likely to lose more money than you ever imagined. But there are plenty of other ways, too. We’ll discuss some of them in my next column…

Alexander Green is the chief investment strategist at InvestmentU.com. See more articles by Alexander here.