Banish Mistakes From Your Portfolio

 | Feb 07, 2014 | 4:30 PM EST
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"Experience is not what happens to you; it's what you do with what happens to you." -- Aldous Huxley

Shawshank Redemption has been one of my top 25 movies since its debut two decades ago. I consider it an American classic.

There are myriad memorable scenes within the movie. One of my favorites is when the character played by Morgan Freeman is before the parole board for the final time talking about how he wished he could go back in time to talk to his younger self. Talk some sense into him. Make him understand. Avoid the tragic mistakes that landed him in prison for most of his adult life.

I have often thought that would be a great capability for a person to possess. Think of all the pain that could be avoided from not making bad business decisions that should never have been made, avoiding love interests that were not worth pursuing.  Of course, we have to include not making those investments that should never have been purchased.

I know that if I could go back and talk to myself decades ago and impart some investment advice, the following would certainly make the list.

  • Don't try to time the market in a big way

I have been investing now for over three decades and I have yet to find a person that could consistently time the market. Equities can remain overbought or oversold for weeks, months and even years at a time. Trying to pick the exact top or bottom is a fool's game.

This knowledge came in handy during the financial crisis during which I had built up just over a 30% cash position slowly in the six months prior to Lehman. The S&P 500 soon looked downright cheap at 1,200, then very cheap at 1,000 and then generationally cheap at 800 before finally bottoming at below 700 in March 2009.

I just kept buying, a little at a time, until I was down to less to a 2% cash position at the end of the panic. I am glad I went back into the market at the same slow incremental pace that I built up a big cash position in the months leading up to the slide. I try to practice this same incremental philosophy whether I believe the market is over or under valued.

  • Don't fall for value traps

Americans generally love an underdog. This leads a lot of investors to buy 'value traps'. These are companies that were once icons but now have eroding business models and market share and whose stocks are selling at what appears to be rock bottom valuations.

The truth is these are almost always longshots that should be avoided. For every feel good and very lucrative story like Apple (AAPL) that comes back strong from a near-death experience there are a half dozen companies such as Filene's Basement, Blackberry (BBRY), Sears (SHLD), Palms, RadioShack (RSH) and J.C. Penney (JCP) that never achieve their former glory. If you feel compelled to buy these iffy turnaround ideas, play them through long-dated, out-of-the-money call options or bull call spreads. This way risk can be mitigated and contained.

  • Don't trade outside regular market hours

Most active traders always wish the markets would be open more than 6 ½ hours a day. Some trade in after hours or pre-market. Don't. It is a bad bet. There is less liquidity and less news data as well as higher volatility and spreads. How many times have we seen a stock go one way just after news or earnings broke in these thinly-traded markets and then completely reverse the move a few minutes later?

Look at Twitter (TWTR) after the bell on Wednesday. The stock shot up several dollars a share as the company beat on top and bottom line headline expectations. Then word came out about slowing user growth a few minutes later, and the stock just got crushed. Anyone buying on the initial uptick got taken out in a body bag.

Since none of us can go back in time, I encourage all investors to sit down and make a list of the worst investment mistakes they have consistently made over the years. Mine sit on a 3x5 card taped to my work desk. Just take five minutes and do it. Your portfolio will thank you for it.

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