Biggest investment mistakes 2005

The concept of contrarian investing is quite easy to understand. Implementing it? Well, that’s another matter. When everyone is running in one direction, do you really have the courage and the conviction to go the opposite way? That’s what contrarians do and they are often very successful at it.

One of the most successful contrarians of recent times is Warren Buffett, the so-called “Oracle of Omaha”, although few people think of him in those terms. But contrarianism is really at the core of his value approach to stock selection, as summed up in this quote: “You need to be greedy when others are fearful and fearful when others are greedy.”

Another fabulously rich contrarian was J. Paul Getty who parlayed an oil company into a multi-billion dollar empire. His words of advice: “Buy when everyone else is selling and hold until everyone else is buying. That is not merely a catchy slogan. It is the very essence of successful investing.”

Assume the unexpected
So what are the contrarians saying these days? One of the best-known Americans to employ this approach to stock selection is Richard Band, editor of a popular newsletter called &t;>Profitable Investing. Speaking at the World Money Show in Orlando recently, he suggested that the core of the contrarian approach is to assume that the unexpected will always happen.

“What is expected is already in the price,” he told the several hundred people at his workshop. “It is the surprises that move the market.”

The higher the consensus that a certain event will occur, the less impact the actual news will have on a stock’s price, he explained. That’s why good earnings reports are so often greeted with a sell-off. Everyone expected it and the share price already reflected the announcement.

Band is increasingly bullish on the prospects for stocks for the rest of 2005 because public opinion is becoming more pessimistic. But he thinks it unlikely that we will see any big move on Wall Street until late in the year. In the meantime, he says that “the most important thing you can do is to avoid the big mistake”. He identified three major errors that investors may be prone to commit this year.

Error #1: Buying on the top tick. If a stock is trading at or near its high, stay away, he advises. The time to take a position is on pull-backs.

Error #2: Allowing your investment costs to get out of control. Band is especially concerned about the high cost of mutual funds, particularly those that incur heavy brokerage charges due to high turnover. He cited a recent Forbes magazine study that found some U.S. funds incurring expenses of 5 per cent to 7 per cent a year. Band expects stock price/earnings ratios to decline over the next decade so market earnings will be modest. High-expense mutual funds will eat up most of the profits, leaving investors with little, a view which was echoed in another presentation by mutual fund legend John Bogle.

Error #3: Investing in over-indebted companies. Band does not like to see a lot of debt on a balance sheet, especially with interest rates rising. “When a corporation takes on more debt than it can service, the share price can go to zero,” he warned. One of the companies he specifically mentioned as being on his personal black list for this reason was our very own Nortel.

There you have it. Avoid those mistakes and you should do just fine in the stock market this year. That’s assuming, of course, that Band’s contrarian view is correct.