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How You Can Guard Against Pitfalls In Your Portfolio? + Vic Wisemann’s Thoughts on: JPM, BAC, GS, IBM, WMT, GLW

Vic Wisemann
InvestorsObserver
Featured Contributor

The current financial crisis seems like a bitter pill to swallow after the record-breaking highs of world markets over the past several years. Not that long ago, it seemed like the extraordinary growth of the economy would never end. Steadily climbing wealth in the developed and developing world alike had many living large, and, in many instances, beyond their means. It is human nature to believe that, despite history’s lessons, this prosperous period would never end.

Yet market peaks and valleys have always been with us. Unfortunately, the press reports ceaselessly on our present economic woes, ignoring the fact that the market will eventually recover and climb again. In the meantime, unsurprisingly, investors are rushing towards perceived safe harbors.

The reality is that this is exactly the wrong time to make any rash moves. The current Bear market, while unwelcome, is a perfect time to review the most common investor pitfalls. Many obstacles to success spring from our emotional ties to money and the poor decisions we make in reaction to those emotions.

Read on to see how you can avoid these common pitfalls in your portfolio.

Let's examine some of the more common pitfalls into which investors fall.

Lack of an Investment Plan
The lack of a concrete plan is at the root of many of the problems investors encounter. A good investment plan should map out your long-term investment objectives, time horizons, diversification decisions, tax consequences, and investment philosophy. It will highlight how all the moving parts work together and it will make you aware of your overall investment strategy. By taking action and creating a plan, you will understand more about how markets work and in turn will allow yourself to become better informed about the relationship between returns, risks and time horizons.

Not Aligning Your Investments with Your Personal Objectives
To achieve success, it is critical to align your investments with your personal objectives. Unfortunately, as obvious as this appears to be, many investors do not have their investments matched to their objectives. In fact, they often have investments that work against their objectives. This mistake is a direct consequence of not having an investment plan.

Trying to Profit by Timing the Market
The chief culprit in many disastrous investment choices is market timing. That is, the widespread tendency to buy into yesterday’s hot performers. In short, emotion all too frequently clouds reason and investors get caught in a downward spiral of buying high and selling low, resulting in very poor long-term performance. Contrary to what pundits may say, anyone who has successfully timed the market did it by accident.

Lack of Proper Diversification
Lack of proper diversification by asset class, by industrial sector, by geographic region and by currency still ranks as one of the most prominent investment pitfalls found amongst the investor community at large. The consequences of undiversified portfolios are excessively high levels of risk. Just look at the number of hedge funds heavy into mortgage back [or is it mortgage-backed?] securities. OK, you can't really look at many of them because most of them are gone and that is the point. This pitfall exposes many investors to much higher levels of potential losses.

Building Portfolios Based on Emotion
Investors sometimes don’t pay attention to the emotion that tends to drive the market up, down and all around. Have you ever wondered why the market rises and falls, sometimes with such dramatic fashion, in such short periods of time? Quite often I find myself thinking of the stock market as if it were a person – a manic depressive person with huge mood swings turning from grouchy and ill tempered to excited and carefree, all in the course of a single trading day.

The key is to recognize when emotion takes hold. No stock is immune from the emotions of the market, but there are some that are more or less affected than others. Stocks in a beaten down sector are particularly susceptible to the emotions of the market. The financial sector is a good example of this.

When there is any bad news in the market, you will see the financial stocks suffer. On the other side, when one of the larger financial firms reports good news, almost all financials will get a lift. Companies like JPMorgan Chase & Co. (JPM), Bank of America (BAC) and Goldman Sachs Group (GS) all ride the waves of emotional trading.

There are a few companies which have shown resilience in a market potentially defined by negative investor emotions. International Business Machines Corp. (IBM) comes to mind as one company which is not being crushed by the waves of market sentiment. The company took a severe hit just like the rest of the market, but in recent months it has moved up over 50% above its November lows.

With its position as a major discount retailer, Wal-Mart Stores Inc. (WMT) is in a position to weather the reactionary storms of the market. Much of the negative sentiment currently revolves around the economy and rising oil prices. WMT's position as the low- cost shopping option makes it more attractive in these times, while its size and range of products should allow it to hold onto any gains it makes in market share.

Corning Inc. (GLW) is another company that has been able to weather this latest storm relatively well. The stock lost three quarters of its value as the markets fell, but has come back to more than double its November lows. GLW's products are used in a wide variety of applications from LCD screens to optical fiber to glass beakers and machineable glass ceramic products. Touching a wide variety of industries allows GLW to operate in almost any economic environment.

For a hedged trade on IBM, consider a July bull put spread with a sold put at least 10% out of the money. These have a potential for a nice return, usually 6% to 12% or more, depending on how much downside protection you build into the trade. Now, 6% may not sound like much, but for a little over a month’s work it is pretty sweet.

Remember, these trades are in the stock market and losses are always a possibility. Be sure the risk factors match your tolerances before you open any trade. Do your research before you trade, follow you plan, and try to have some fun.

If you have had any additional thoughts, ideas or ways to get emotion out of your portfolio, please e-mail me at vwisemann@InvestorsObserver.com.