If you're an investor, knowing what not to do can be even more important than picking the right stocks. After all, even the best stock pickers can hope to earn about 15%-20% returns each year. On the other hand, one bad move can literally wipe out your entire portfolio.
If you make these three investment moves, you may as well be burning your money. Source: flickr user Purple Slog
With that in mind, here are three things that you definitely don't want to do with your money, and why they are such bad ideas.
Dan Caplinger: During long bull markets like we've seen over the past six years, it's always tempting to use the leverage available from using margin debt in order to multiply your positive returns. With interest rates at extremely low levels, some brokers will offer you financing at as little as 1%-2% interest, making it easy to keep up with finance charges as long as the stock market keeps moving in the right direction. Indeed, many dividend stocks have yields that are higher than prevailing rates, making debt maintenance even easier.
The problem comes later, though, when a market correction comes. As your portfolio value falls during a bear market, your margin debt becomes a larger percentage of the value of your total investments. If that percentage gets too large, then your broker will automatically start selling assets in order to pay off the margin loan or at least reduce it to a more manageable size. Those forced sales typically come at exactly the worst time, when shares have already lost considerable value -- and before any potential rebound.
Investing on margin always involves some risk, but the key is to make sure you don't get overleveraged. Like many things, using margin loans in moderation isn't a problem, but getting hooked on them can leave you penniless faster than you'd imagine.
Jordan Wathen: I can think of no better way to lose money than to take a stock tip from anyone without doing your own due diligence.
The simple fact is that people buy stocks for any reason, some good, and some bad. Without proper investigation on your own, you may be buying companies that are vastly different than what they appear to be. Altria (MO -0.93%) is known as a tobacco company, but it also has a growing alcohol business. Disney (DIS -0.10%) is known for Mickey Mouse, but ESPN is increasingly becoming its "bread and butter," so to speak. CarMax (KMX -0.25%) is a car dealership, but behind it is a hidden car auction business. These are all vastly different businesses than they appear to be.
Doing your own due diligence is paramount to understanding the factors that make a stock worth buying or selling. Never take a stock tip at face value without investigating it on your own.
Matt Frankel: One effective way to lose your money is to start buying out-of-the-money options, which is about as much of a lottery ticket as you can buy.
Now, there are some responsible uses of OTM options. For example, if I have a large short position in a certain stock, I could buy a few OTM calls as a hedge against a rapid price increase, thereby capping my potential losses.
However, one common "rookie mistake" is to buy a large chunk of OTM calls or puts as a speculative investment in order to receive a big payday. For example, Citigroup (C 0.91%) is trading at about $49 per share as of this writing, and the January 2016 $60 calls are trading for about $1.10.
So, if Citigroup has a phenomenal year in 2015 and shoots up to $70 before expiration, you'll make nearly 10 times your original investment. However, the much more likely scenario is that your contracts will still be out of the money at expiration, and therefore worthless.
Options can be an excellent investment tool when used responsibly by investors who know what they're doing. However, when used the wrong way they are a good way to lose all of your money rather quickly.
Dan Caplinger owns shares of Walt Disney. Jordan Wathen has no position in any stocks mentioned. Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends CarMax and Walt Disney. The Motley Fool owns shares of CarMax, Citigroup Inc, and Walt Disney. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
FAQs
Let's say that you start with the time frame in mind, hoping an investment will double in value over the next 10 years. Applying the Rule of 72, you simply divide 72 by 10. This says the investment will need to go up 7.2% annually to double in 10 years. You could also start with your expected rate of return in mind.
How do people lose all their money in the stock market? ›
Ultimately, many people lose money in the stock market because they simply can't wait long enough for meaningful profits to arrive. History shows that the longer you remain invested (in diversified stocks) the less chance you have of losing money in the stock market.
What are the 3 investing mistakes? ›
Key Takeaways
The worst mistakes are failing to set up a long-term plan, allowing emotion and fear to influence your decisions, and not diversifying a portfolio.
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It states that you can comfortably withdraw 4% of your savings in your first year of retirement and adjust that amount for inflation for every subsequent year without risking running out of money for at least 30 years.
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Joy's version of the rule is simply to take the cost of something, divide it by the number of times you'll use it, and if it's less than $1 per use, she buys it. If it's more than $1, she walks away from the purchase (obviously there are some exceptions and I'll outline how those get handled in a moment).
Why do 80% of traders lose money? ›
One of the primary reasons traders lose money is the absence of a clear trading strategy. According to research by Bloomberg, over 80% of day traders quit within the first two years, often due to insufficient strategies.
Do 90% of people lose money in the stock market? ›
90% Retail Investors Lose Money - Rediff.com. Only the top 5 per cent profit makers account for 75 per cent of profits. Saad Bhakshi, an aspiring pilot, is addicted to stock market investing. He mostly dabbles in stocks and invests in IPOs.
What is the quickest way to lose money? ›
Gambling is one of the most popular ways to lose money quickly. It is also one of the most effective, as it preys on our natural human tendencies to take risks and seek immediate gratification. There are many get rich quick schemes that promise easy money with little or no effort.
What is the number 1 rule investing? ›
Rule No.
1 is never lose money. Rule No. 2 is never forget Rule No. 1.” The Oracle of Omaha's advice stresses the importance of avoiding loss in your portfolio.
20 Investment Mistakes to Avoid
- Expecting Too Much. Having reasonable return expectations helps investors keep a long-term view without reacting emotionally.
- No Investment Goals. ...
- Not Diversifying. ...
- Focusing on the Short Term. ...
- Buying High and Selling Low. ...
- Trading Too Much. ...
- Paying Too Much in Fees. ...
- Focusing Too Much on Taxes.
As far too many investors have found out the hard way, investing mistakes can be quite costly! When looking at potential options on who you can trust to invest your money without making mistakes, consider each of the 3 “C”s: Cost, Conflicts, and Competence.
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The best stock advice websites include Motley Fool Stock Advisor, Seeking Alpha, and Moby. These platforms offer in-depth stock analysis and investing research to help you make informed decisions.
What are the 10 stocks The Motley Fool recommends? ›
See the 10 stocks »
The Motley Fool has positions in and recommends Alphabet, Amazon, Chewy, Fiverr International, Fortinet, Nvidia, PayPal, Salesforce, and Uber Technologies. The Motley Fool recommends the following options: short June 2024 $67.50 calls on PayPal. The Motley Fool has a disclosure policy.
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The Motley Fool is more narrow and focuses on recommendations from its team of analysts, while Zacks' recommendations are culled from analysts across Wall Street. The Motley Fool also focuses on long-term buy-and-hold strategies in next-gen companies, centering value.
What is the Rule of 72 in simple terms? ›
Do you know the Rule of 72? It's an easy way to calculate just how long it's going to take for your money to double. Just take the number 72 and divide it by the interest rate you hope to earn. That number gives you the approximate number of years it will take for your investment to double.
What is the Rule of 72 Warren Buffett? ›
Here's how it works: To understand the Rule of 72, divide 72 by the expected annual rate of return. For example, if you invest Rs 1 lakh in an investment with an expected 8% annual return, divide 72 by 8 to get 9. This means it will likely take about nine years for your money to double, growing to Rs 2 lakh.
Does the Rule of 72 really work? ›
The Rule of 72 is an estimate, and more accurate at around 8 percent interest. The further the interest rate or inflation rate is from 8 percent, the less precise the result will be.
What does the Rule of 72 predict? ›
The Rule of 72 predicts how long an investment will take to double based on a fixed annual interest rate. The rule is this: 72 divided by the interest rate number equals the number of years for the investment to double in size. For example, if the interest rate is 12%, you would divide 72 by 12 to get 6.
