CHICAGO — In more than 40 years of investing and writing about investing, I’ve made enough mistakes of my own and learned enough about the mistakes of others to have put together a few simple rules for profitable investing. I can’t promise that avoiding mistakes like these will guarantee success, but I do feel that doing so will greatly improve the odds in your favor.
Here are a half-dozen that I consider the most important:
DON'T TRY TO GO IT ALONE
To me, trying to pick individual stocks or bonds is a loser’s game. Decades of experience shows that even full-time professionals do a poor job in trying to beat or even meet the market, so why should you think that you can do better? Instead, stick with mutual funds, especially index funds (funds that set out to track indexes such as the Dow Jones or S&P 500).
STOP ALL THAT BUYING AND SELLING
If you insist on picking individual stocks or bonds, never allow yourself to forget that every time you buy or sell, you’re helping your broker to get rich. While there are plenty of “experts” around who will tell you that the old buy-and-hold philosophy of investing is obsolete, don’t you believe it. Just ask Warren Buffet, the most successful investor ever.
Buy only companies that you feel are solid, and hang on to them until and unless there is a major change in the company’s fundamentals. As Vanguard’s John Bogle puts it, “Buy right and hold tight.”
DON’T FALL FOR ‘THE PAST PREDICTS THE FUTURE’ TRAP
There is a natural—even understandable—tendency for us to look at an investment’s past history as a dependable predictor of what to expect in the future. The trouble is that it doesn’t always work that way. Experience shows that it’s not uncommon for an investment to have better-than-average performance one year and mediocre or even dismal performance the following year.
This situation is so common that the Securities & Exchange Commission (SEC) issued a directive requiring mutual fund issuers to tell investors that a fund's past performance does not necessarily predict future results. While the SEC directive refers only to mutual funds, the caution applies equally well to individual investments.
The moral of this tale: don’t make an investment solely on the basis of recent past performance; always research the fundamentals as well.
FORGET TRYING TO ESCAPE RISK
There is no such thing as a risk-free place to put your money. While stuffing your money under a mattress will avoid stock market risk, it simply exposes your money to other risks, most obviously that old bugaboo: inflation. One year later, the purchasing power of that money will be lower by whatever the rate of inflation. Assuming an inflation rate of 2%, $1,000 under your mattress after one year will have a purchasing power of only $980. Imagine what it will be after 10 years.
What about bank CDs or “super safe” treasury bills or bonds? While they will be “safer” than that money under the mattress, they will still be money losers as long as they pay a return that is less than the current rate of inflation.
While stocks carry the greatest potential for loss, they also carry the greatest potential for gain. That’s why virtually every financial pro agrees that the best formula for potential gain and minimizing risk is a well-diversified portfolio including stocks, bonds, and cash equivalents.
DON’T FOLLOW THE HERD
Another inherent human tendency is to do what “everyone else” is doing. Teenagers are perhaps the most dramatic example of this odd behavior (dress the same, talk the same, idolize the same performers) but they’re not alone. Have you ever been walking along a sidewalk and seen a group of people staring skyward at some unknown object? If you have, dollars to doughnuts, you stopped to look up, too.
While this sort of follow-the-herd behavior is quite harmless in most circumstances, not so when it comes to investing your money.
When the market is at a peak and everyone else is buying, this may be your time to sell, and vice-versa. Warren Buffett may have summed it up best when he said, “You should be greedy when others are fearful and fearful when others are greedy.”
KEEP EMOTIONS OUT OF INVESTMENTS
No matter how well your portfolio is diversified and allocated, it will always be vulnerable to some degree of risk. That’s why you must not allow your emotions to overrule common sense when it comes to dealing with market volatility.
Sharp market downturns, even recessions, are relatively common in our society and are a normal part of a free economy. When the market is in a slump, your emotions may scream that this is the time to cash out. Before you succumb to that emotional imperative, think about your long-term goals for that money. Remember, the market has always recovered from slumps and gone on to new record highs.
Avoiding the six mistakes I’ve laid out cannot guarantee investment success alone, but I’m confident that doing so will put you a step up on that long road to financial security.
Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult an accountant or tax adviser for advice regarding your particular situation.
Have a question or comment? E-mail our editor Dave Davis at [email protected].