Save Yourself From This Costly Mistake

In turbulent markets, it's harder than ever to keep a long-term focus. But if you give into the temptation to make kneejerk reactions to short-term market moves, you'll make what could prove to be huge mistakes with your money.

Below, I'll share two stories in which investors who paid too much attention to short-term results cheated themselves out of sizable rebounds. But first, let's take a look at how short-term thinking sets you up for failure.

Even many Wall Street professionals suffer from not having a long enough time horizon with their investments. Seeking to make a quick score, they focus on sensational news events and other near-term catalysts for a company in the hopes of seeing its stock move sharply, rather than on its prospects for the future.


But what drives stock price movements in the short run isn't always important to long-term investors. By losing focus on what really determines a stock's intrinsic value, short-term traders can see their confidence in a stock disappear at exactly the moment when it's most poised for a turnaround.

Mutual funds provide great examples of this phenomenon, because many mutual fund shareholders look closely at short-term performance. When a fund is doing well, it attracts huge amounts of assets -- yet when it falters, fund shareholders exit in droves.

The perfect example is Bruce Berkowitz and his Fairholme Fund. Berkowitz established an amazing track record of successful performance over the long haul, outperforming the S&P 500 every year from 2004 to 2010 and earning kudos as the Fund Manager of the Decade from Morningstar.

Yet like the Sports Illustrated curse, Berkowitz had a horrible 2011. Huge positions in financial stocks and other risky plays went badly, as the stocks failed to respond to the recovery in the way Berkowitz apparently expected. Bank of America (NYS: BAC) found itself dealing with a crisis of confidence as the bank went all-out to raise capital. Meanwhile, AIG (NYS: AIG) failed to execute on its long-term plan to repay the U.S. government and get the Treasury to exit its equity position. At the same time, Sears Holdings (NAS: SHLD) plunged as its core retail business continued to underperform its peers, with a disastrous holiday season forcing the company to close stores and retrench.

The bad performance led to huge outflows from the fund in 2011, with $5.4 billion exiting Fairholme between January and October. Yet so far in 2012, Fairholme is among the market's leaders with a huge gain of 31%. B of A rebounded as its capital situation has improved, while moves by Sears CEO Eddie Lampert suggest that the company may be able to unlock value even without a retail rebound.

Investors who bailed out after big losses in 2011 have to be upset about missing the turnaround. Yet the problem came from losing their focus on the big picture. Berkowitz made no such mistake, remaining confident even as his shareholders lost hope. Those who stuck around haven't made back all their losses, but they've still seen enormous improvement.

Another example comes from the fixed-income realm. Early last year, bond guru Bill Gross took flak for his perfectly intuitive yet enormously wrong bearish call on Treasuries. Arguing that huge new issuance of U.S. government debt made low rates unsustainable, Gross made a big bet on a fall on Treasuries in his Total Return bond fund, with a move similar to what those buying the ProShares UltraShort 20+ Year Treasury ETF (NYS: TBT) were making.

When that call went badly, Gross ended up near the bottom of the barrel. Investors sold in droves as competing funds outperformed. Yet again, the move proved short-lived, as Gross admitted his mistake and adjusted his asset mix to take advantage of prevailing conditions. The result was huge outperformance over the past half-year, again putting the mutual-fund counterpart of Pimco Total Return (NYS: TRXT) in the top 10% of its group and demonstrating the fund's long-term staying power.

With so much information, it's easy to feel like you have to pay attention. But amid the noise, it's easy to forget that most so-called "news" doesn't really have an impact on the reasons why you pick an investment. Unless news suggests a fundamental shift for a company, reacting too strongly to it can get you in trouble.

To keep your eyes on the true target, you need to own stocks you can count on for the long haul. You'll find three of them in the Motley Fool's latest special report on how you can retire rich. It's free, so grab your copy today while it's still available.

At the time this article was published Fool contributor Dan Caplinger learned too much the hard way. You can follow him on Twitter here. He owns shares of Fairholme. The Motley Fool owns shares of Bank of America. Motley Fool newsletter services have recommended writing puts on ProShares UltraShort 20+ Year Treasury. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is a lifesaver.

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