Investors should be wary of an investment professional that recommends that an investor jump into the latest trends. It is always amazing to hear what trends investment professionals recommend to investors. Unless you are a professional trader, chasing trends such as rising commodities prices, trading stocks, or concentrating your portfolio in dividend paying stocks, these ideas are usually the wrong approach. The key to successful long-term investing is diversification. While there may be short-term potential in the hottest trends these ideas also carry significant risk.
Over the last couple of years commodity prices have risen dramatically. Back in 2008 the price of oil rose above $150 a barrel. Many retail investors got burned by jumping into energy futures or exchange traded funds at or near the top of the market. Gold is now the commodities market leader. Money is flowing into gold futures and exchange traded funds. Gold may continue higher as investors seek a safe haven for their investments. However, concentrating your savings in gold now would be a mistake. Gold is trading around $1900. That doesn’t mean it cannot fall significantly. If your investment professional recommended a small allocation to gold early on then you have benefited from this move, but now is not the time to jump in with both feet. Diversification is the key long-term. The risks right now are too great to justify potential returns.
Surprisingly, because interest rates are so low, many investment professionals are recommending that investors try and take advantage of the stock market’s volatility. Right now the volatility index is trading around 40, which means that over the next 12 months the market can move 40% in either direction. While that may provide opportunities for trading gains, it also means that investors can lose in either direction too. The market has seen wild 500 point swings in either direction in the same week. Investment professionals attempting to trade these moves got burned, while investors with diversified portfolios with appropriate allocations to investment grade fixed income were more insulated to short-term trading losses. While the market’s volatility remains at extremely high levels, the overall performance of the market this year is almost flat.
Investment professionals are also recommending that investors, particularly retirees, concentrate investments in dividend paying stocks. While yields may be attractive on certain stocks, these yields may not last forever. Investing in a company solely for its yield ignores the risk of the underlying stock. An example of this is Barnes and Noble. Investors seeking yield pushed the stock to $21 a share earlier this year because it offered a high dividend. Once Barnes and Noble cut its dividend investors that bought the stocks for its $2 a share dividend lost nearly $10 in the underlying stock. Another example is Ford. Years ago Ford was trading around $16 per share and was yielding nearly 7%. It was one of the highest yields on the street. Unfortunately, investors lost as much 50% on the stock when Ford slashed its dividend. Investment professionals should recommend quality stocks, which often pay a dividend. However, buying a stock solely because of the yield is not an investment strategy.
There are always new trends. These trends come and go. Taking a long-term approach is the only way to avoid losing money unnecessarily chasing a trend. If you have a short-term investment time horizon, it is even more important not to chase a trend, and seek safety for your savings.