Topic: Dividend Stocks

How to Avoid Losing Money on Investments: 5 Key Tips to Consider

February 1, 2021|by Scott Clayton

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The best way to learn how to avoid losing money on investments is to look for ways to make lower-risk decisions and invest in high-quality stocks

Are you interested in finding out how to avoid losing money on investments? While there are, of course, no guarantees, you should begin by focusing on high-quality stocks, and avoiding investing strategies focused on frequent selling and excessive speculation.

In general, the top stocks to buy will often offer both capital-gains growth potential and regular dividend income.

How to avoid losing money on investments: Invest in high-quality dividend stocks

If you stick with top-quality, dividend-paying stocks, you are much less likely to lose money over the long term. At the same time, the income you earn can supply a significant percentage of your total return—as much as a third of your gains. Additionally, dividends are more dependable than capital gains as a source of investment income.

Note, though, that when it comes to investment safety, a long history of steady dividends is more important than a current high dividend yield.

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How to avoid losing money on investments: Practice caution with model portfolios and practice stock trading accounts

Model portfolios and practice accounts have a lot in common. They both distract investors from long-term investing goals. Practice accounts and model portfolios don’t teach you anything about a long-term conservative strategy that meets our Successful Investor criteria. They instead focus your attention on making fast profits with quick stock market gains. Rather than an educational experience, practice accounts and model portfolios are a little like play-money sessions at Las Vegas, where gambling novices can learn to play casino games without risking any real cash.

There is a large random element in short-term stock market results. Model portfolios are marketed to only show you the gains you could make. In reality, it will take months or years before you know if your choices are likely to provide attractive long-term returns. In fact, the real test will come only when you see how you do in the next bear market.

Public-relations efforts on practice accounts often refer to them as good places to learn about day trading and options trading, which are big money earners for online brokers. But most non-professionals who get involved with day trading or options trading wind up losing money if they stick with it long enough. In that respect, they are a lot like casino games.

How to avoid losing money on investments: Don’t invest too much in speculative stocks

A speculative stock is a higher-risk, more aggressive stock with uncertain prospects. Speculative stocks may offer significant returns to investors—but they will also have risk to match.

The odds are against you when you invest in speculative stocks and companies that are not yet making money. Some if not many of these companies will never make any money.

When investing in speculative stocks, limit speculative holdings to a small part of your overall portfolio. Also, focus on investment quality as much as possible when looking for aggressive stocks, with the potential for higher returns.

How to avoid losing money on investments: Use our three-part Successful Investor approach

1. Invest mainly in well-established, mostly dividend-paying companies;
2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities);
3. Downplay or avoid stocks in the broker/media limelight.

Bonus Tip on how to avoid losing money on investments: Avoid stock options

An option is a contract between a buyer and a seller, based on an underlying security, usually a stock. The buyer pays the seller a fee, or premium, for certain rights to the stock. In exchange for the premium, the seller assumes certain obligations. Options trade through stock exchanges, with prices quoted each day.

Each contract has a limited life span, or time to expiry—usually less than nine months. The expiry date is the date on which the contract expires. The strike, or exercise price, is the price at which the rights granted to the buyer can be exercised. There are two types of options:

1. “Calls” give the holder, or buyer, the right to buy the underlying security at a specified strike price until the expiration date. The seller of the call has the obligation to sell or deliver the underlying security at the strike price until the expiry date, if the option holder exercises the option.
2. “Puts” grant the holder or buyer the right to sell the underlying security at the strike price until the expiry date. In turn, the seller or writer of the put has the obligation to buy or take delivery of the underlying security until expiration, if the option holder exercises the option.

Trading stock options generates a lot of brokerage commissions, which is why many young, aggressive brokers specialize in it.

But many of these brokers wind up dropping out of the investment business or choosing another specialty. That’s because it’s impossible to build a lasting clientele by trading stock options, since you place your clients in investments that will almost certainly cause them to lose money.

Even so, many aggressive investors find stock options hard to resist, especially during market upturns.

Here’s a look at seven major pitfalls associated with stock options:

1. High costs: You pay commissions each time you buy or sell stock options. Commissions eat up a large part of any stock option profits you make, particularly if you trade in small quantities.
2. Limited room for error: If an option is not sold or exercised prior to its expiration date, it expires and is worthless.
3. Direction: In order to make money with stock options, you have to be right about the direction of a stock’s price. If you buy a call option, you’re betting the price will rise. With a put option, you’re betting the price will fall.
4. Time: The fact that options are valueless once they expire means an option holder must not only be right about the direction of both the price change in the underlying interest and the magnitude of the move, but also about when the price change will occur.
5. Magnitude: Assuming you’re right about the direction of the stock price, you must also be able to predict the minimum amount that a stock will move. If the stock moves up or down by only a small amount before expiry, you’ll still lose money.
6. No ownership rights: Option owners participate only in the potential benefit of the stock’s price movement.
7. Risk of total loss: An option holder runs a much greater risk of losing the entire amount paid for the option in a relatively short period of time.

What strategies do you employ to help you avoid losing money on your investments?

It’s all too easy to lose money on investments. What steps do you take to balance that risk with the goal of making a substantial return?