Avoid These Investment 'Bargains'

Avoid These Investment 'Bargains'
When is "such a deal" not such a great buy?

Christine Benz is Morningstar's director of personal finance, editor of Morningstar PracticalFinance, and author of the Morningstar Guide to Mutual Funds. Meet Morningstar's other investing specialists.

Like an extended warranty on a new appliance or the time-share pitch that's disguised as a "free" vacation, savvy consumers know that some deals that look good on the surface aren't all they're cracked up to be once you read the fine print. The same holds true in the investing marketplace.

A few months back, I shared some tips for unearthing a few true investment bargains. But what about those investments that seem like good deals but really aren't? I'll discuss some of them in this week's article.

Looking for Securities with a Cheap Share Price

Ford Motor and General Motors are currently trading at less than $2 and $3 per share, respectively. When storied companies like these two hit the skids, it may look tempting to gobble up their stocks in a bet that they won't go belly-up. After all, you can buy 100 shares of each for less than $500, and if they do manage to resuscitate themselves, you could stand to gain big. That's not the stupidest idea in the world--as long as you go in knowing that it's similar to a bet you might place in Vegas. If your bet works out, you're buying the drinks. If not, you could lose everything, as equity shareholders would likely lose almost everything if the two companies ended up in bankruptcy court. (For proof that gambling on near-busted companies is a risky proposition, just talk to shareholders of Fannie Mae, Freddie Mac , and American International Group

Hoarding Company Stock--Even When You've Bought It at a Discount

Many publicly traded companies give their employees the opportunity to purchase their stock at a discount to the current share price. That might seem like a good deal. But loading up on your company's stock can be dangerous, particularly if you're hoarding shares of your company at the expense of building a well-diversified portfolio. Remember: You already have a lot tied up in your company's financial health and your industry via your job, so it's a mistake to compound that effect by socking a disproportionate share of your portfolio into your employer's stock. To be on the safe side, limit employer stock to no more than 5% of your overall portfolio.

Buying a Cheap Fund, Then Paying Commissions on Small Purchases

Exchange-traded funds have recently taken off in the marketplace, in part because their expenses can be lower than mutual funds that invest in the same basket of securities. Before you venture whole-hog into ETFs, however, take a step back and think about your investment style. If you plan to make a lump-sum investment and let it ride, the ETF may well be the best bet for you. However, that's not so if you trade frequently or make small purchases at regular intervals (and dollar-cost-averaging is a great way to invest, by the way). That's because you'll pay a commission to buy and sell ETFs, and those charges could quickly erode any cost savings versus plain-vanilla mutual funds. Ditto for paying a transaction fee to buy a fund in a mutual fund supermarket or buying a front-load fund, even if its expenses are low.

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