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New to direct investing? Part 8

Lessons from the Investing School of Hard Knocks Add to ...

Gail Bebee is the author of No Hype - The Straight Goods on Investing Your Money. She can be reached at gbebee@gailbebee.com; her website is www.gailbebee.com. This is part eight of a 12-part series for people that are new to investing on their own.

I've been investing on my own for about 10 years now. In that time I've made my share of investing mistakes. I think I've learned a thing or two from my misadventures. In the interest of helping readers avoid some of the dumb, and not so dumb but unsuccessful, things I have done, this article recount some of my mistakes, and more importantly the lessons I have learned in the Investing School of Hard Knocks.

About 10 years ago, Labour Sponsored Investment Funds (LSIF) were very popular. The tax treatment of qualifying LSIFs was enticing: 15 per cent tax credit from the federal government, 15 per cent tax credit from most provincial governments plus a 5 per cent Ontario tax credit for research-oriented LSIFs.

Mesmerized by the substantial tax savings, I bought the Canadian Medical Discoveries Fund, an LSIF which invested in medical research companies and qualified for all the tax breaks. What I didn't pay enough attention to was what the fund invested in - small and micro-cap Canadian companies involved in medical research.

New to direct investing? The series

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I was effectively signing up to be a venture capitalist, not the best bailiwick for a retail investor. I also didn't check what I would be paying the fund company to manage the fund. Looking back, I am astounded to discover that the management expense ratio was over 5 per cent, much higher than the 2-2.5 per cent of the average Canadian equity fund at the time. Even worse, I bought this in my RRSP and could not use any tax loss to reduce any capital gains I had made in my regular account.

Fast forward eight years, when the investment could be sold without losing the tax breaks: the fund price was worth less than half my initial outlay and was continuing to fall. Even worse, fund redemptions were restricted because investors were bailing out as soon as the tax benefits crystallized. As well, the Ontario government decided to ratchet down the tax credits, effectively shutting down the flow of new money into LSIFs.

So many mistakes in just one investment! Here are the lessons other investors should learn from my foray into LSIFs:

• Understand what you are buying.

• Avoid funds with high fees.

• Buy the investment, not the tax treatment.

• Don't put high-risk investments in your RRSP.

I admit that I got sucked into the technology mania of the late 1990s. I bought into Nortel on its way up to $123, then watched it fall. I decided to bail out when the shares hit $75 and I had lost about 25 per cent of my investment. It was an expensive lesson to follow the crowd. Again, there is more than one lesson to be learned from my investing misadventure:

• Be very wary of investing manias, they usually result in price bubbles which eventually get pricked and deflate rapidly.

• As part of your investment purchasing decision, decide on your puke point i.e. how much you are willing to lose before selling out.

As a keen rookie DIY investor, I read all sorts of reports on what stocks to buy. Drug companies were frequently cited as a good investment for retail investors. A small Vancouver-based drug company, was in the news with a promising drug to cure an age-related eye disease which can result in blindness. Reinforced by a glowing analyst's research report and rosy future profit expectations, I bought in. Unfortunately, the drug was still in development and subsequent test results indicated it was not as effective as originally billed. You can guess what happened next. Eventually, I sold the stock at a significant loss. Once again, more than one lesson from my mistake:

• Avoid companies which only promise profits

• Buy drug companies with a sufficiently large line-up of approved products that the company will not fail if problems arise with one of its drugs

• Don't put too much weight on stock analysts' reports on companies.

Early in my career as an online discount brokerage client, I entered an order for 800 shares of Laidlaw and pressed the buy button. The order didn't appear to go through, so I tried again. After a few minutes, the account registered both purchases. I decided to keep the extra shares, thinking there was no problem overweighting a holding in a company in waste management, bus services and ambulances. Wrong on three counts, three more lessons learned:

• Find out how to properly use your discount broker's trading system before making any purchases

• Promptly correct an investing error

• Diversify your stock holdings because any company can go bankrupt, even a seemingly safe one in essential services like garbage, ambulances and school buses. Laidlaw was eventually felled by financial fraud.

The cost of attending the Investing School of Hard Knocks is high. Make sure you get a return on your tuition by learning from your own investing mistakes.

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