Avoid 4 crucial mistakes when you use a discount broker

While there may be good reasons to switch to a discount broker, low commission fees will not solve most investment problems and can often lead to one of four crucial investing mistakes.

Switching to a discount broker makes sense for many investors. It’s sure to cut your per-trade commission costs. But high per-trade brokerage commissions are rarely if ever the sole reason for poor investment results. If you are unhappy with your results, you should check to see if you are making one or more of these four main investing mistakes:

1.    Buying and selling too often.

2.    Buying too many low-quality investments.

3.    Failing to diversify.

4.    Buying too many stocks in the broker/media limelight.

Low commissions are better than high commissions, of course. But low commissions can warp your investing decisions. You may decide that low commissions give you the freedom to sell at the first sign of trouble. However, all stocks go through troubled periods from time to time. High-quality stocks manage to overcome their troubles. Low-quality stocks go from bad to worse.

Some of your investments may be headed for a huge rise in the long term. If you always sell at the first hint of trouble, you can wind up selling your best stocks at a temporary low, just before a big rise.

Diversification works best with high-quality stocks

If you delve into low-quality stuff like penny stocks or stock options, it takes more than low commissions to turn the inevitable losses into profits. Getting out at the first hint of trouble can limit your losses, but that’s not the same as making money.

Diversification can balloon your profits in the long term, if you focus on high-quality investments. But it’s much less help with low-quality stuff. That is why we advise you to put strict limits on your holdings of speculative stocks (10% for conservative investors and 30% for more aggressive investors are the guidelines we set out in our advisory on more aggressive investing, Stock Pickers Digest). It’s why we advise you to stay out of stock options altogether.

Finding a good stock broker is hard but not impossible. Some successful investors view their brokers as a valuable source of investment research, information, and advice. But they keep in mind that brokers operate under enormous conflicts of interest. That's why they carefully assess a broker’s advice before acting on it.

In the long run, the best way to cut commissions is by sticking to high-quality investments and making fewer transactions. If you do that, and diversify across the five main economic sectors, and downplay or avoid stocks in the broker/media limelight, you are following our Successful Investor approach.

If your broker can help you do that consistently, the extra commission cost per trade is probably worth it.

Courtesy Fundata Canada Inc.© 2015. Patrick McKeoughis a professional investment analyst and portfolio manager. He is the host of TSINetwork.com, where this article first appeared. Investments mentioned are not guaranteed and carry risk of loss.