Analysts disproportionally cover companies whose fundamentals correlate with industry peers. These firms, designated as bellwether companies, are shown to have significant stock price effects on companies with little to no analyst coverage within their same industry.
The paper offers two propositions. The first proposition states that companies whose fundamentals are similar to those of other companies in their industry attract more analyst coverage. The second proposition states that earnings estimates of companies with a large analyst following, or “bellwether firms,” influence the returns of companies with similar fundamentals but for which information is sparse because of limited analyst coverage. These ideas are shown to have a significant impact on return and volatility characteristics. Click here to read the entire abstract. Abstract Author - Paul R. Rossi, CFA
1. Expecting too much or using someone else’s expectations Investing for the long term involves creating a well-diversified portfolio designed to provide you with the appropriate levels of risk and return under a variety of market scenarios. But even after designing the right portfolio, no one can predict or control what returns the market will actually provide. It is important not to expect too much and to be careful when figuring out what to expect. Nobody can tell you what a reasonable rate of return is without having an understanding of you, your goals, and your current asset allocation.
2. Not having clear investment goals The adage, “If you don’t know where you are going, you will probably end up somewhere else,” is as true of investing as anything else. Everything from the investment plan to the strategies used, the portfolio design, and even the individual securities can be configured with your life objectives in mind. Too many investors focus on the latest investment fad or on maximizing short-term investment return instead of designing an investment portfolio that has a high probability of achieving their long-term investment objectives.
3. Failing to diversify enough The only way to create a portfolio that has the potential to provide appropriate levels of risk and return in various market scenarios is adequate diversification. Often investors think they can maximize returns by taking a large investment exposure in one security or sector. But when the market moves against such a concentrated position, it can be disastrous. Too much diversification and too many exposures can also affect performance. The best course of action is to find a balance. Seek the advice of a professional adviser.
4. Focusing on the wrong kind of performance There are two timeframes that are important to keep in mind: the short term and everything else. If you are a long-term investor, speculating on performance in the short term can be a recipe for disaster because it can make you second guess your strategy and motivate short-term portfolio modifications. But looking past nearterm chatter to the factors that drive long-term performance is a worthy undertaking. If you find yourself looking short term, refocus.
5. Buying high and selling low The fundamental principle of investing is to buy low and sell high, so why do so many investors do the opposite? Instead of rational decision making, many investment decisions are motivated by fear or greed. In many cases, investors buy high in an attempt to maximize short-term returns instead of trying to achieve long-term investment goals. A focus on near-term returns leads to investing in the latest investment craze or fad or investing in the assets or investment strategies that were effective in the near past. Either way, once an investment has become popular and gained the public’s attention, it becomes more difficult to have an edge in determining its value.
6. Trading too much and too often When investing, patience is a virtue. Often it takes time to gain the ultimate benefits of an investment and asset allocation strategy. Continued modification of investment tactics and portfolio composition can not only reduce returns through greater transaction fees, it can also result in taking unanticipated and uncompensated risks. You should always be sure you are on track. Use the impulse to reconfigure your investment portfolio as a prompt to learn more about the assets you hold instead of as a push to trade.
7. Paying too much in fees and commissions Investing in a high-cost fund or paying too much in advisory fees is a common mistake because even a small increase in fees can have a significant effect on wealth over the long term. Before opening an account, be aware of the potential cost of every investment decision. Look for funds that have fees that make sense and make sure you are receiving value for the advisory fees you are paying.
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Thoughts to help investors stay focused
Every investor knows that his or her portfolio is at least partially at the mercy of the market itself, with overall market conditions playing a huge role in general gains and losses. Most investors have probably heard the terms "bull market" and "bear market" used to describe these conditions, but not all of them truly understand the difference between the two, or what to do when a bear market hits. Investors at any level should take note of these distinctions to make good investments and properly manage a portfolio as the market shifts over time.
The difference between the two types of markets is quite simple:
The first challenge when facing a bear market is recognizing it. Because short-term trends can't predict whether the overall market will continue to rise or fall, it can take a sharp eye and a keen investor's instinct to be truly confident in one's moves when looking at a short period of time (less than a few months, for example). Fortunately, most economists agree that this determination can be made by a percent change in multiple indexes. If the change is at least 20% in either direction (rising or falling), the market can more safely be declared bear or bull. Depending on how long an investor is willing to ride out the trend before making gut decisions, selling and buying comes at the risk of the market trending the opposite direction in the long term. The outcomes of such decisions sometimes feel arbitrary, making the old idiom of "playing the stock market" all too accurate.
Bear markets aren't caused by any one thing. Since the 1950s, there have been 9 bear markets brought on by a variety of issues. Some bear markets follow major political occurrences (formation of alliances, military actions, changes in federal financial regulations, etc.). Others are brought on by a combination of economic forces, rapidly rising stock prices and/or large-scale changes in investors' decisions as a result of the dot-com and housing bubble bursts, for example. Perhaps most interestingly, a bear market may even be brought on by the social consensus of investors themselves due to something called "investor psychology." For example, some investors may be compelled to sell when others are selling and buy when others are buying. By jumping on the proverbial bandwagon and following others' lead, investors can create a swirl of activity that drastically affects the market, even if things had actually been going rather smoothly.
Some small consolation to all this is that bear markets are usually shorter, lasting around 15-18 months--a mere fraction of the average duration of a bull market. Despite their shorter length, however, average losses are typically 40% or so, making the task of surviving even a particularly brief bear market seem like an investor's nightmare. The question is: should the average investor remain invested when a bear market rears its ugly head?
If you've got the staying power, sticking it out in a down market can be well worth it. If you are investing with a long-time horizon, especially, you can afford to be a bit more aggressive with your moves, as it allows more time to make up for short-term losses. If you lose an average of 40% over the course of 15-18 months but have several years left until your target of retirement, you have a significant amount of time to potentially make up those losses and continue to make substantial gains.
It's important to briefly note here the relationship and distinction between a bear market and a recession. While bear markets are some times accompanied by a recession, a recession is an economic trait, classified by at least two consecutive quarters of negative growth in the GDP. A bear market, on the other hand, is a market trait, generally defined by at least two consecutive months of decline in stock prices. Although the two measurements can be closely related, one is a measure of the country's overall economic stability while the other is a measure of trends in stock prices.
Whether you'll be able to wait out the bear market (or a recession) and rebuild your assets to your satisfaction depends upon what seems like a deluge of factors: the duration of the downward trend, the future of the market, the strength of your investments and the choices you make going forward. With careful planning, safe, long-term investments and a cool head, however, these obstacles can be surmounted. Ultimately, you as the investor will need to examine your own financial goals to make that call.
Paul R. Rossi, CFA