Avoid This Common Investment Pitfall

| September 29, 2008 | 0 Comments

This weekend, the entire world stood on pins and needles.  Congress worked feverishly on a $700 billion bank rescue plan.  I was happy to see our elected officials finally putting in a few honest hours of work.  I guess they realized saving the US banking system might be important.

Of course Congress is working hard this weekend.  They’re supposed to start their winter recess today.  They’d scheduled a little break, nothing big.  They’re just taking the rest of the year off.  Nice work if you can get it huh?

So, back to the $700 billion rescue plan.

The funny thing about this legislation, many people aren’t sure it’s going to pass.

But that’s the least of our worries right now.  All this news was overshadowed by Citigroup trying to rescue . . . I mean buy . . . part of Wachovia.  Then concerns about European banks started hitting the news.  Fortis, a huge European bank, received a $16 billion cash infusion from the Netherlands, Belgium, and Luxembourg.  Then news hit that Bradford & Bingley, a major UK mortgage company, would be nationalized.

We warned you.

Long time readers know how difficult the markets have been.  They also know I’ve been warning people to hedge their portfolios.  At no time has that become more important than now.  But, there’s a huge mistake that many investors make.

What’s that mistake?

It’s not knowing what you’re buying.

Now, I’m not just talking about doing due diligence and knowing about your stock or ETF.  It’s more than that.  It’s knowing why you’re buying an investment.  Knowing what’s going to move it up or down.  And understanding how it will perform compared to other investments.

Let me give you an example.

Back in May, the Dow Jones Industrial Average was trading at 13,010.  It was a perfect time to hedge some of your portfolio.  One easy way to hedge is by buying gold.

Why gold?

Historically, gold is a counter-cyclical investment.  That simply means when the market’s doing well, gold goes down.  And when markets are falling, gold goes up.  Investors tend to buy gold as a way to profit when turmoil and uncertainty hits the market.  Kind of like now.

Over the last few months the Dow has fallen considerably.  On May 1, it was trading at 13,010.  As I write this, the market’s at 10,858.  That’s a 16% loss in only 4 months.

Now if you’d hedged your portfolio by purchasing gold, you’d be doing much better.  Take a look at the streetTRACKS Gold Shares ETF (GDL).  This ETF actually purchases and holds gold bullion.  When you buy the ETF you get a piece of the gold they have in storage.  Back on May 1, the Gold Shares ETF was trading at $83.99.  Today it’s up more than 5% to $88.73.  Not bad.

But here’s the risk.  Instead of buying the Gold ETF you might have bought a Gold Company ETF.

What’s the difference?

First as we discussed above, the Gold ETF buys and holds gold.  The gold company ETF, like Market Vectors Gold Miners ETF (GDX), buys and holds shares of gold mining companies.

A huge difference.

The Gold Company ETF will move up or down based on the stock prices of gold companies.  On May 1, Market Vectors Gold Miners ETF was trading at $42.65 a share.  Now you can pick up all you want at $35.34 a share.  That’s a loss of more than 17%.

Do you see why it’s important to know what you’re buying?  If you bought the wrong ETF your nice gain would have been a huge loss.  And your portfolio would not have been properly hedged.

Remember, it’s important to know not only what you are buying but why. Hopefully you’ll avoid making the same mistake.  Now if we could only find a way to avoid the next mistake Congress makes…

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Category: Stocks

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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