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Big Blunder, Little Lessons
You probably think you have very little in common with investment bank J.P. Morgan. You don't have billions in the bank, you don't operate out of a New York City skyscraper, and you don't trace your lineage to a guy who ruled much of the financial world from the late 1800s to early 1900s.
But you may have one rather important connection: an ability to make colossal mistakes with your investment portfolio.
In May, the investment bank announced a $2 billion trading loss, and the number seems to get ever bigger by the day. What's particularly surprising is that throughout the financial crisis, the firm has been held up as the model of financial prudence, the one bank that managed to emerge from the downturn with its reputation, and much of its money, intact.
So let J.P. Morgan's missteps be a lesson to all of us who dabble in the financial markets. No matter how big or small, core investing principles are paramount. These lessons will take you far, no matter if you don't have a 10-figure bankroll.
Know thy investments
This is so simple, but accounts for much of the losses investors endure every day. Make sure you understand what you're investing in. If you don't, steer clear. What's astonishing about J.P. Morgan's loss is that it came from credit default swaps--the type of exotic security that helped cause the near collapse of the financial system four years ago.
To avoid a similar fate, make a clear-eyed assessment of your investing abilities. If you don't have the time or expertise to carefully choose investments--don't. Leave it to a professional, or invest in index mutual funds or exchange-traded funds. Most managers fail to beat the markets over the long-term, anyhow, so it's a safer--and well diversified--bet.
This is also particularly true when it comes to trading things like options. Hedging sounds like a wonderful thing in practice (part of the J.P. Morgan trade was meant to protect against losses), but in the wrong hands, can turn a bonfire into an inferno. There's a reason Warren Buffet called derivatives "weapons of financial destruction." So when it comes to complex investments, take the gun out of your own hand. Or, better yet, don't buy one in the first place.
Know when to fold them...
...Not just when to run. A few weeks before he appeared to announce the losses, J.P. Morgan CEO Jamie Dimon called rumors of the trading mishap "a tempest in a teapot." It's unclear what was going on inside the firm at the time, but it seems reasonable to assume that they failed to get out of their positions quickly enough. Maybe it was pride, incompetence, or just dumb luck.
J.P. Morgan now has the fun task of unwinding its trade under the glare of intense media and industry scrutiny. It's easy to be taken advantage of with your vulnerabilities laid bare. Had they had acted more quickly after realizing their original mistake, they could have saved themselves millions, if not billions, in losses.
One way to address those issues (luck aside) is to have a solid, bullet-proof investing plan. Something that prompts you to buy and sell at pre-determined targets. That way, you'll be less susceptible to holding on to losers and selling winners when the going gets tough. Too many investors fall into the buy-low, sell-low trap--a recipe for an unpalatable portfolio.
Matthew Malone is a staff writer for RothIRA.com, a leading retirement and Roth IRA resource. Matthew is also a contributing writer to CBS SmartPlanet. His work has appeared in The New York Times, Cosmopolitan, Smartmoney.com, Fortune.com, Forbes.com, and other publications.