The recent tech collapse has sucked up not only your money, but most likely your pride too. You’re probably feeling foolish about how you let greed take over your typically sane investment psyche.
Now, move on. The smarter investors will learn from these errors and use that newfound knowledge to actually make money the next time a bubble bounces into town.
Because another bubble is on the way. While we can only speculate when it will come and in what sector it will be (optics stocks have been looking pretty pricey, no?), we want to make sure you don’t make the same mistakes again.
There are some lessons to be learned — in no particular order — from this recent market frenzy so you don’t deplete your investment confidence again.
Valuations Do Matter “Most investors don’t know the businesses they’re invested in. They just know it’s hot,” says Deena Katz, a certified financial planner with Evensky Brown & Katz in Coral Gables, Fla.
Just because a stock goes up doesn’t mean things are necessarily good. “You have to pay attention to valuations. You can’t disassociate a stock with the company that’s behind it,” says Bob Olstein, the manager of the Olstein Financial Alert, and a former accounting firm consultant.
Red Hat is the perfect example: The stock rocketed as much as 450 percent after its November 1999 initial public offering, even though the company had no cash on its books. (Red Hat is down 86 percent this year.)
So know your company. Read the financial statements. Try to gain an understanding of how management thinks by listening to management interviews, surfing corporate Web sites and reading press releases. Then if the stock goes down, you may have a good understanding why.
Never Buy on Margin “We’re almost better off not having margin in the market,” says money manager Ashok Ahuja, of Icor Capital. Investors who trade on margin are taking a loan to buy shares. They use the securities they have in a brokerage account as collateral to borrow more money so they can buy twice as much as they can afford.
So if you don’t have the funds to buy 500 shares of what you believe is the new hot stock, you can pay for 250 shares and buy the rest on margin, using your current account holdings as collateral. Hopefully, if the stock rockets, you make a bundle and you easily can pay back your loan.
If the market slips, the value of the securities in your portfolio may, too. But those securities are part of your collateral. If their value falls below a minimum level — typically 50 percent of the borrowed funds, although firms can require more — the account may no longer be enough to guarantee your loan. Then you may get a dreaded margin call, where your broker requires you to bring your account back up to the required levels by either depositing additional funds or securities into the account or making full payment on your margin loan.
But if the market is down, odds are good that your money is all tied up in fallen stocks, so you could find yourself in desperate straits — actually owing more money than you initially put up for the loan.
An overabundance of investor optimism caused too many investors to get hit with margin calls. Of the more than 2,400 people that responded to our recent online broker’s survey, almost 40 percent said they had faced a margin call at some time. They were forced to ante up more cash for their positions or dump shares of stock into a falling market.