How buying hot stocks could burn youWhy is it a bad idea to pick stocks, watch their performance and then sell them if they drop below a certain price, as opposed to choosing a mutual fund?
The trouble is people make those promises to themselves and they don't keep them. There's actually behavioral research on this done by people who have studied both psychology and finance. Most people don't like the idea of a loss, and so once their stock falls, even though they promised themselves that they would watch it, they say to themselves, "Well, I think it'll come back," and they wait. What they don't realize is that stocks have no memory. Just because you bought the stock at $50 a share, doesn't mean that it's ever going to return to that. So a lot of times what will happen is, people will buy it and hold it after things have changed a lot since the day they bought it, and it'll just keep going down.
“There's a hot stock today, too, that won't be a hot stock later.”
There was a a group of stocks in the 1970s called the Nifty 50 and at the time Wall Street was saying, "You can buy these stocks and hold them forever and never think twice about them, because they are such great companies they will be there forever." Well, you want to hear some of the names of those? Polaroid, which dealt with cameras, fell 91 percent and the stock never ever came back to the price people had paid for it. Another one was Avon, the makeup company. We don't think of that as a hot stock today, but in the '70s that was a hot stock.
The point is, there's a hot stock today, too, that won't be a hot stock later. You just don't know it. Because you don't know it, it's dangerous to buy just one or two stocks.
Instead you buy numerous stocks through a mutual fund. Mutual fund managers make mistakes. Often, they've said to me (that) about 40 percent of their stock picks they consider mistakes. And they're brilliant. They are running all kinds of tests on these companies and if they can't do it 100 percent of the time, then why do you, an individual, who has no idea how to look at the numbers, think you can do a better job? Just because you watched a TV show and someone said it looks like a good stock?
Invest differently for short-term goalsWhat are some do's and don'ts for people with short-term investing goals, such as saving for a down payment on a house? What types of investments make sense and which don't?
If you're within five years of needing your money, history shows that the stock market can go down significantly during that time period and you could end up with less money than you originally put in. So the rule of thumb is that that money shouldn't go into the stock market. You need something safer. Safer could be CDs that you would get at a bank; it could be a money market fund. I draw a distinction here -- the words "money market" are on two different types of accounts that are not the same. There's a money market fund and a money market account. Typically the interest rate on a money market account is not as good as a money market fund and yet they're both fairly safe -- not 100 percent safe, but very, very safe.
You can get a money market fund through a mutual fund company. You can shop for CD rates on Bankrate.com. Sometimes there are high-interest savings accounts that are as good as money market funds, and you can also find those at Bankrate.com. You can perhaps put money real simply into just a high-yielding savings account. You should be able to get right now close to 5 percent interest on a money market account, or one of these high-yielding savings accounts. You don't lock your money up -- it's there if you need it for the down payment and you're not taking a risk with it.