Find Out If You're a Dangerous Investor

Are you dangerous to your own financial health?

When people ask me tax-preparation questions (I'm an inactive CPA) or legal questions (I finished law school 20 years ago), I tell them that it would be dangerous for me to give them advice. I'm not an active CPA who regularly prepares tax returns, and I'm not a practicing lawyer. If I can't remember how to look up case-law citations, how can I render quality legal advice?

While I'm quick to admit to my lack of expertise in many areas, many people who are new to the stock market won't do the same in investing. It takes some degree of humility to admit, but a lot of individual investors are dangerous to their own financial health. Here, in Part 1 of a two-part series, I list some ways that investors can harm their own financial health. If you know what to avoid, it might help your portfolio have a healthier future.

They fundamentally misunderstand the market.

The market provides liquidity for buyers and sellers of publicly traded businesses. That's it. It's not Las Vegas or Atlantic City. The markets don't exist just so paper can be traded or gambled on. Stocks are shares in real businesses with real assets that generate real profits.

Even some investors who understand that stocks represent real businesses often have unrealistic expectations. They expect a full and fair cash bid for their asset (stock) each and every day. That's expecting too much. Turn this expectation game on its head (i.e., expect less) and you'll be a much less dangerous investor. The net result of a market that is all-cash with a three-day settlement and a ready bid on every business day is easy enough to identify: inefficient pricing.

The average stock oscillates an average of 50% per year, far more than is justified by the underlying business value. Prices change more than value changes. For example, I highlighted Hasbro (HAS - commentary - Cramer's Take) in countless RealMoney columns dating back to December 2000. (Back then, it was trading at $10; it's now at more than $20.) Because my calculation of Hasbro's business value is $25 per share, it doesn't matter if I get a full and fair bid today, as long as I'm confident in my calculation. Knowing what Hasbro (the business) is worth, is an indispensable aid to determining rational buy and sell points for the stock.

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At time of publication, Alsin and/or ACM was long Hasbro, Bristol-Myers and Tenet, although holdings can change at any time.

Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor and portfolio manager of The Turnaround Fund, a no-load mutual fund. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to [e-mail]. Click here to receive Arne's latest favorite stock picks from his newsletter, The Turnaround Report.