I started investing when I was in college by taking some family gifts and putting them into a mutual fund (which I then sold to buy Christy’s engagement ring). Through graduate school and early in my law practice, I always took an active role in handling my investments with any excess student loans, income or gifts. As a result, by the time I started working with clients as an investment adviser, I had over ten years of personal investment experience. During that time, I also read about personal finance and investing almost religiously and then once I started practicing law, I saw first-hand the mistakes made by some of my clients and/or their advisers.
Along the way, I made my fair share of investing mistakes, and I want you to avoid them as much as possible. Fortunately, these involve my own money and not any of my clients’. Rather than provide a long list of mistakes, I want to only go into one or two at a time but discuss them in more detail.
Mistake 1: Reading Yahoo message boards and consequentially buying a penny stock.
In 2006, when I was still fairly fresh out of law school, I bought Patriot Scientific (PSTC) based on something I read on a Yahoo message board. If I remember correctly, Patriot Scientific was a patent troll, or something like that, and was supposed to receive a significant amount of money related to some patent dispute. I bought it around $0.36/share and stared at the computer screen as its price danced up and down by a penny here and there (each penny represented a 3% gain or loss though at those prices!). Apparently, a bunch of other people got duped and bought the stock as well, and before long it traded at about double my initial investment. I sold all of it for about $0.51/share and felt like a professional trader. Then the price kept rising. Foolishly, I bought back in at $0.63/share with even more money (still a small amount though) and sold most of my investment a couple of weeks later at $1.26/share. The price dropped again, and so I bought a little bit more, but then I lost interest in staring at the ticker, and about six months later I sold the rest of it at around $0.60/share (its worth $0.00 now). Overall, I made seven trades (3 buys/4 sells) and paid $51.65 in commissions to make $598.75, all due to luck.
Fortunately, I had very little invested in this mistake, but I learned the following lessons:
- Don’t get stock tips from a message board. This should be common sense, but there are thousands of people that frequent hundreds of different website message boards. If the Ivy league MBAs running billion dollar mutual funds cannot consistently beat the market, then website message board investors are likely to do much worse.
- Penny stocks are penny stocks for a reason. These types of companies fly in the face of almost all research about what factors of companies drive stock performance, and they are extremely high risk. Physicians need to treat their investments as if they are running a marathon, and not like 26 miles of sprints, so run away from penny stocks (and other ultra-high risk investments) and those marketing them.
- You need an exit strategy (cue future article) when investing in individual stocks or any other investment that you intend to sell eventually. I clearly did not have one in this situation, so when the stock rose in value after I sold it, I then foolishly bought more!
- Frequent trading is generally a fools errand, especially if you have a day job. I don’t have time to stare at stock charts all day, and most physicians can make much more per hour, with much less risk, seeing patients than trading stocks. Even professional traders can fail wildly, as you must keep in mind that for each hedge fund or mutual fund manager buying a given stock, another one is selling it, and both think they are brilliant for doing so.
- Small investments, even if lucky or brilliant, will be destroyed by fees. All of my investments in this stock were $1,000 or less. My $599 in profit was swallowed up by $52 in fees (9%) plus another 25% or so in short-term capital gains tax in a taxable account. Small investments should usually be made in no load mutual funds or $0 transaction fee ETFs, not individual stocks.
One additional consideration is that at that time, I was in my mid-20s, had studied investing for a few years, and knew better that to do this, but yet I still did. At the time, I likely thought it was a good experiment with a small amount of money, and perhaps it was. But many people think it is a legitimate way to earn a living. If you are working with an investment adviser who has control over your assets, you need to make sure that frequent trading and penny stock trading are not part of their methods, and keep a close eye on your transactions, as they occur, to make sure that it doesn’t become part of their methods.