Are You a Dangerous Investor? Part 2

One rule that physicians follow is to do no harm. Unfortunately, the average investor can -- and often does -- do a lot of harm to his or her portfolio through avoidable mistakes. In this second installment of my two-part series on being a dangerous investor, I'll review a few more ways that investors can hurt themselves in their capital-allocation endeavors.

They follow the crowd.

Most investors are comfortable when they're part of the crowd. Following the crowd is irrational when the market is in full-fledged panic mode and stocks are being sold at hefty discounts. But many investors aren't detached observers; they're uncomfortable holding fast in the midst of panic.

I outlined the rational and less dangerous strategy for Turnaround Report subscribers early this year. Namely, you need to make fear your friend. Rather than sell in the face of panic, I doubled up on Office Depot (ODP - commentary - Cramer's Take), IMS Health (RX - commentary - Cramer's Take) and Humana (HUM - commentary - Cramer's Take) earlier this year. Each increased at least 50%, easily outpacing the market.

They try to time the market.

One of the most dangerous things you can do as an investor is take an all-or-nothing approach. This market-timing strategy means that you're either 100% invested or not invested at all in the stock market. Although many investors embrace this approach, it's blatantly irrational and generally quite harmful to your wealth.

I spoke to many investors who were resolutely bearish and completely out of stocks in late 2002 and early 2003, when the market was faltering. But risk cuts both ways. Sure, a market can decline by 20% at any given time. But as we've found out in the past several months, the market can just as easily see a 20% increase.

If you were parked in cash to try to "safeguard" your capital, you have also lost an opportunity to participate in an equity rally. And, as sellers of equities learned in 1987, 1990, 1994 and countless other tough markets, sometimes stock prices don't come back.

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At time of publication, Alsin and/or ACM was long IMS Health and Humana, 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.