Seven Deadly

Investment Sins:
How to Save
Your Portfolio.
Now.
Seven Deadly Investment Sins:
How to Save Your Portfolio. Now.

After nearly 30 years of providing world-class investment research, and nearly 15 years of portfo-
lio management experience, Zacks has identified “7 Deadly Investment Sins” that have plagued
so many investors. At some point everyone has been guilty of at least one of these “sins” and if
allowed to continue, it can destroy your portfolio.

The good news is that I have identified these “sins” for you in this special report. On the follow-
ing pages I provide a detailed analysis of these “sins” and explain why they are so deadly to a
portfolio.

It is a great pleasure to share the results of my analysis with you in the hope you will be able to
avoid these pitfalls in the future. I am confident that avoiding these “sins” will help you make your
investment goals become realities.

-Mitch Zacks

Contents:
Seven Deadly Investment Sins ........................................................ 1

Sin #1: Market Timing ................................................................. 2

Sin #2: Investing On Emotions .................................................. 3

Sin #3: Lack of Diversification ................................................... 5

Sin #4: Not Knowing Your Time Frame ................................... 6

Sin #5: Not Understanding The Effect of

Inflation on Cash Vehicles ........................................... 7

Sin #6: Chasing Returns ............................................................ 8

Sin #7: Procrastination ............................................................. 10

About Zacks ..................................................................................... 11

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1 Sin #1: Market Timing
“I’m going to wait until market conditions improve before I invest…”

Market timing is a strategy where an investor attempts to predict the future direction of the market
and then move in and out of the market accordingly. This is one of the most dangerous strategies
ANY investor can employ.

There are essentially two reasons why market timing is so dangerous:

1. Over the short term, the market does not always move logically or predictably. This makes
it nearly impossible to time the market. Simply put, it can’t be done.

2. Even if you were able to beat the odds and create a system that accurately times the mar-
ket, the payoff would not be worth taking that level of risk.

Investors who attempt to time the market are at risk of missing periods of exceptional returns. This
can have a large negative impact on an otherwise well planned investment strategy.

Suppose for a moment your timing strategy was slightly off and you missed out on just 30 days of
strong performance each year. The result would be disastrous to your overall return. The graph
below illustrates the effect of missing the one best month in a calendar year for the period of 1995
- 2007.

Cumulative Returns
January 1995 - December 2007

S&P 500 300.58%

S&P 500 minus best month of
77.10
each calendar year

We should note that although we feel timing the market is an impossible strategy, we have proven
that there are inefficiencies in the market that allows investors to accurately identify individual
stocks that are poised to outperform (or underperform) the overall market. After years of quantita-
tive research, Zacks has discovered that the most reliable and accurate predictor of future stock
price movement are earnings estimate revisions.

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2
Sin #2: Investing On Emotions
“The market is never going to survive this crisis, I’m going to cash…”

Whether it’s the morning newspaper, CNBC, the radio or the internet, at any given time you can
find a pundit or “market expert” who is predicting major doom and gloom for the market. No mat-
ter the situation, at the time of their occurrence it inevitably seems like the entire U.S. economy
is at risk. However, it is important to note that these “reporters” are dependent on attracting an
audience, and they are much more likely to draw in a crowd by predicting the very best or worst
scenario rather than telling you the truth… that whatever turbulent period we are in is par for the
investing course.

If you take a look at the past eight decades, every year is annotated with a reason to not invest in
the equity market. Over that same time, we have witnessed the strongest economy in the history
of the world that has provided investors like you with stronger returns than any other investment
vehicle.

Take a look at these world events:

1934: THE GREAT DEPRESSION 1961: BUILDING OF THE BERLIN WALL 1987: STOCK MARKET CRASH
1935: SPANISH CIVIL WAR 1962: CUBAN MISSILE CRISIS 1988: WORST DROUGHT IN 50 YEARS
1936: ECONOMY STILL STRUGGLING 1963: KENNEDY ASSASSINATION 1989: SAVINGS & LOAN SCANDAL
1937: RECESSION 1964: GULF OF TONKIN 1990: IRAQ INVADES KUWAIT
1938: WAR IMMINENT 1965: CIVIL RIGHTS MARCHES 1991: RECESSION
1939: WAR IN EUROPE 1966: ESCALATIONS OF THE VIETNAM WAR 1992: RECORD BUDGET DEFICIT
1940: FRANCE FALLS 1967: NEWARK RACE RIOTS 1993: CONGRESS PASSED LARGEST TAX
1941: ATTACK ON PEARL HARBOR 1968: USS PUEBLO SEIZED INCREASE IN HISTORY
1942: WARTIME PRICE CONTROLS 1969: MONEY TIGHTENS; MARKET FALLS 1994: INTEREST RATES ON THE RISE
1943: INDUSTRY MOBILIZES 1970: CAMBODIA INVADED; WAR SPREADS 1995: DOLLAR AT HISTORIC LOWS
1944: CONSUMER GOODS SHORTAGES 1971: WAGE-PRICE FREEZE 1996: GREENSPAN'S "IRRATIONAL
EXUBERANCE" SPEECH
1945: PRESIDENT ROOSEVELT DIES 1972: WATERGATE SCANDAL 1997: COLLAPSE OF THE ASIAN MARKETS
1946: CHURCHILL'S "IRON CURTAIN" SPEECH 1973: ENERGY CRISIS 1998: LONG TERM CAPITAL COLLAPSES
1947: BEGINNING OF THE COLD WAR 1974: NIXON RESIGNS 1999: Y2K PROBLEM
1948: BERLIN BLOCKADE 1975: FALL OF VIETNAM 2000: DOT-COM STOCKS PLUMMET
1949: RUSSIA EXPLODES A-BOMB 1976: ECONOMIC RECOVERY SLOWS 2001: TERRORISTS ATTACK ON U.S. SOIL
1950: KOREAN WAR 1977: MARKET SLUMPS 2002: CORPORATE SCANDALS:
1951: EXCESS PROFITS TAX 1978: RISE IN INTEREST RATES 2003: U.S. INVASION OF IRAQ
1952: U.S. SEIZES STEEL MILLS 1979: OIL PRICES SURGE TO NEW HEIGHTS 2004: INFLATED OIL PRICES
1953: RUSSIA EXPLODES H-BOMB 1980: INTEREST RATES AT ALL-TIME HIGHS 2005: TRADE DEFICIT
1954: DOW TOPS 300- MARKET "TOO HIGH" 1981: BEGINNING OF A SHARPLY RISING RECESSION 2006: LEBANON CONFLICT 14,164.53
1955: EISENHOWER FALLS ILL 1982: UNEMPLOYMENT REACHES THE 2007: CREDIT CRUNCH
1956: SUEZ CRISIS DOUBLE DIGITS 8,000

1957: RUSSIA LAUNCHES SPUTNIK 1983: RECORD BUDGET DEFICIT

1958: RECESSION 1984: TECHNOLOGY BUBBLE BURSTS 4,000

1959: CASTRO SEIZES POWER IN CUBA 1985: EPA INITIATES BAN ON LEADED GAS LINE
1960: RUSSIANS DOWN U-2 PLANE 1986: DOW AT 1800 - "TOO HIGH" 2,000

What has history taught us? No matter

1,000
DOW JONES
INDUSTRIAL AVERAGE INDEX
how grim or bearish individuals around 1934-2007

you may feel, over time the U.S. equity

market will produce the most consistent
and strongest return for your investments.
If you are appropriately diversified, you
should not concern yourself with the mar-
ket’s daily volatility. 1940 1950 1960 1970 1980 1990 2000
Dow Jones Industrial Average Inedx is the property of Dow Jones & Company

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3
Sin #3: Lack of Diversification
“I have 10 mutual funds, I am well diversified…”

You may be committing one of the worst investment “sins” and not even know it. Many inves-
tors mistakenly believe that because they have several stocks or mutual funds that they are well
diversified. However, to ensure true diversification you have to look deeper into your investing
strategy.

Let’s suppose that you had the noble intentions of creating a diversified portfolio and went out to
the market and purchased several mutual funds each with a different investment style. You may
not realize it, but mutual fund holdings, often have a great deal of overlap. Take Microsoft for
example. You may own a balanced fund, a growth fund, a technology fund and a global fund and
each of these may have a position in Microsoft.

What exacerbates the situation is the fact that mutual funds do not publish their holdings on a
regular basis. Even mutual fund research firms, such as Morningstar, typically only receive the
underlying holdings once a quarter. This makes it nearly impossible for you to have a full under-
standing of the true sector and position weightings of any mutual fund.

In a different scenario let’s say you hold individual stocks. No overlap is possible here, but you
still may not be as diversified as you think even if you own 10, 20 or even 50 stocks. You need to
dig deeper to see your diversification across market cap size, sector and style.

At Zacks, we divide the equity universe into 16 different sectors. If you are managing a portfolio
of individual stocks, it is important for you to understand your sector weightings in order to ensure
proper diversification. Even if you are convinced a particular sector is going to outperform all oth-
ers, you never want to have all of your proverbial eggs in one basket.

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4
Sin #4: Not Knowing Your Time Frame
“I’m in (or close to) retirement,
I just need fixed income investments at this time…”
If you are in or are approaching your retirement age, you should have a portion of your allocation
in fixed income investments. However, it is just as important for you to maintain some exposure
to equities.

The average life expectancy for Americans continues to rise. It is more important than ever for
you to consistently earn returns in retirement so you do not outlive your money.

With advances in medical technology, the average life expectancy has increased from 69.7 in
1960, to 77.8 in 2004 (see below). Couple this with the rising costs of health care and inflation and
this creates a scenario where, for most individuals, fixed income investments are not enough.

CDC’s National Center of Health Statistics

Life expectancy at birth

Life expectancy at birth

United States, selected years 1900-2004
(Data are based on death certificates)

Birth Year Expected Age

1900 47.3
1950 68.2
1960 69.7
1970 70.8
1980 73.7
1990 75.4
2000 77.0
2004 77.8

The truth is there is not a one size fits all solution. Only through a comprehensive evaluation of
your goals, risk tolerance and time horizon can an appropriate allocation between equity, fixed
income, cash and alternative investments be established.

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5
Sin #5: Not Understanding The Effect
of Inflation on Cash Vehicles
“I want my money in cash. It is safe then…”

You may feel that an investment in cash is “safe” and it will not decrease in value. Although it is
true that a cash investment is dramatically less risky than an investment in the stock market, infla-
tion will erode at the real value of your portfolio over time.

What is even more staggering is that once you take into the effect of taxes and inflation, a cash
investment will likely have a negative return.

3.7%

0.7%
-0.7%
T-Bill After
Return Inflation*
After
Inflation*
& Taxes**
For this reason you never want to hold too much money in cash at ANY time.
* Assumes a 3% annual rate of inflation
We should note that you should always maintain approximately six months of living expenses in
**Assumes a 37% tax rate
cash for your emergency fund. However, outside of that, your portfolio should not be over allo-
cated to cash. Don’t let yourself fall into the false assumption that cash is safe.

* Assumes a 3% annual rate of inflation

**Assumes a 37% tax rate

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6
Sin #6: Chasing Returns
“My friend made a fortune in Energy stocks;
I want to switch my investments to this asset class now…”

One of the deadliest actions you can take as an investor is to chase returns. Whether it is pur-
chasing a new mutual fund, changing investment advisors, switching newsletters, or selecting a
new stock, it is a common pitfall for investors to follow the hottest trend.

If you follow this instinct then essentially you are managing your portfolio by looking in the rear
view mirror and letting your desire for huge returns interfere with rational thinking. An investment
philosophy like this will cause you to feel as if you are “always late to the party” and your portfolio
will suffer greatly.

To gain a better understanding of how detrimental chasing returns can be to your portfolio, let’s
imagine it is January 1, 2000. As you analyze the returns from 1999, you see that the biggest
winners were investments in Japan and in the Technology Sector. You decide that this is where
you need to invest and who would blame you; all of your friends and colleagues are bragging to
you about how great their portfolio has been doing, and there are still plenty of “analysts” out there
telling you the party is not over.

Next you go out and purchase two low cost mutual From First To Worst
funds that track the following indexes:
1999
■■ MSCI Japan: Up 61.77% in 1999 100%
80%

■■ S&P North American Technology Sector In- 60%

dex: Up 88.87% in 1999 40%

20%

■■ These indexes both dramatically outper- 0%

MSCI Japan S&P S&P 500
formed the S&P 500 index which returned
61.77% Technology 21.04%
21.04% in 1999. Sector
88.87%
Move ahead to January 1, 2001. You take a look at
your investments, and this is what you see:
2000
■■ MSCI Japan: Down 28.07% in 2000 0%
-5%
-10%
■■ S&P North American Technology Sector In- -15%
dex: Down 37.84% in 2000 -20%
-25%
-30%
■■ This compares to just a 9.11% loss for the -35%
-40%
S&P 500 in 2000. MSCI Japan S&P S&P 500
-28.07% Technology -9.11%
This is a common error that millions of investors make Sector
every year. It is very common for funds to move from -37.84%

“first to worst.” In fact, typically the greatest inflow

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into a given mutual fund is immediately after it has generated above average performance and
immediately before it begins a period of underperformance. Today the potentially same costly
mistake is being made by thousands of investors as they flock to energy stocks and investments
in China.

Investing is a process that takes time and patience. The real way to benefit from an asset class
is to be involved before it becomes hot and knowing when to pull profits off the table. It is critical
to look at forward looking indicators to identify stocks and sectors to invest in before the profits
are made.

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7
Sin #7: Procrastination
“I need to take some time and think
everything through before I make any changes...”

With all of the various choices in the investment world, it is easy to understand how you can feel
overwhelmed and put off making any changes to your portfolio. But perhaps the worst decision
you can make is no decision at all.

A portfolio that is constructed with a variety of mutual funds and/or stocks that does not have an
overall strategy is doomed for failure. You will constantly be in a state of uncertainty and never
know when to buy or sell your stocks and mutual funds. This will lead to poor and irrational deci-
sions.

We are not recommending you invest with a manager or follow a newsletter without fully under-
standing the philosophy, but put yourself on a strict timeline to make a decision. Evaluate the
process and examine it to make sure it avoids all of the previous “sins” we have discussed.

Make no mistake, there are many newsletter writers, brokers, investment managers and “gurus”
who are just as guilty of committing these “sins” as individual investors. That is why it is no sur-
prise that so many mutual fund managers underperform the market as well.

Disclaimer: This article is provided for informational purposes only and does not constitute legal or tax advice. Zacks
Investment Management, Inc. is not engaged in rendering legal, tax, accounting or other professional services. Publica-
tion and distribution of this article is not intended to create, and the information contained herein does not constitute, an
attorney-client relationship. Do not act or rely upon the information and advice given in this publication without seeking
the services of competent and professional legal, tax, or accounting counsel.

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About Zacks

Mitch Zacks

Mitch serves as Director of Quantitative Modeling and Senior Portfolio Man-

ager of Zacks Investment Management. Mitch is integrally involved in Zacks’
research efforts and has portfolio responsibility for several of the strategies.
Mitch has been featured in various business media including the Chicago
Tribune and CNBC. He wrote a weekly column for the Chicago Sun-Times
and published the acclaimed book about quantitative investment strategies,
Ahead of the Market. Mitch has over 10 years of investment experience.
He has a B.A in Economics from Yale University and an M.B.A in Analytic
Finance from the University of Chicago.

Zacks Investment Management

Zacks Investment Management, a wealth management boutique, is the world’s leading expert on
earnings and using earnings estimates in the investment process. We are a wholly owned sub-
sidiary of our parent company, Zacks Investment Research.

Through our rigorous investment process we provide individual and insti-

tutional clients with a level of customization and personalization unavail-
able at most investment firms. Client portfolios are managed using a
unique combination of Zacks independent research and Zacks quantita-
tive models that have proven year after year to deliver superior results.

Call 800-245-2934 today to learn more about our powerful program or to

request a free consultation.

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