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Lesson #4 Do Not Try To Find The Next Microsoft
You might read an article detailing how this stock will be the next Microsoft. I see these ads, and articles all the time. So you read the article and think if I just invest a few thousand in this stock it might be the next Microsoft and I will be a millionaire. Do not buy into this mentality. For every Microsoft, there are dozens if not hundreds of companies that went bankrupt. When you buy these companies what you are doing is really gambling and speculating, not investing. You are hoping that this company will be the next Microsoft. The odds are stacked against you completely. As I like to tell people if you are going to gamble at least go to Vegas and have fun. Benjamin Graham states that the “The most realistic distinction between the Investor and a Speculator is found in their attitude toward stock market movements. The Speculator’s primary interest lies in anticipating and profiting from market fluctuations. The Investor’s primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which they certainly should refrain from buying and probably would be wise to sell”.
Lesson #5 Do Not buy Companies That Have Not Proven Themselves
This lesson is related in many ways to lesson #4. The point here is that do not buy into companies that are losing money on hopes that they will in the future produce profits. New companies that have not proven themselves or earned profits are highly speculative and usually are bad investments. Many of these companies are tech companies that are producing products that will hopefully produce a profit in the future. The problem is that the technology sector is one of the most competitive ones out there. If a company is inventing robotics that will revolutionize household chores, or military tactics there are likely 100 companies with the same exact idea. This is one of the reasons Warren Buffett, and Benjamin Graham hated technology companies. If the company has a strong balance sheet, is producing earnings, and trading at a low valuation the stock might be worth a look. However, a beginning prudent investor would avoid young companies that have no history of profitability.
Lesson #6 Do Not Listen to Stock Tips From Anyone
Unless you happen to be friends with Warren Buffett, it is highly recommended never to listen to stock tips from friends, the media, or anywhere else. It does not matter if the stock is a penny stock, or a blue chip like Wal-Mart. The main reason for this is you have no idea what this person’s track record is. Many of the money managers who appear on CNBC, Bloomberg or other media outlets have less than impressive track records. It is hard to believe, but MOST money managers managing billions of dollars in assets underperform the market index. This means it would be better to buy the Dow Jones ETF instead of investing with these money managers. In fact 80-90% of money managers underperform the index. This is for a simple reason. The stock market is a network of all the money managers, hedge fund managers, individual investors etc. On average the market will return 10% a year. However many mutual funds charge a 1% fee, plus there are many hidden fees which add 1% or more. If you purchase an index fund since it is not actively managed the fees are very low, sometimes even below 0.1%. So on average the index funds will outperform money managers, with far lower risk.
This all does not mean you cannot beat the market, otherwise I would not be writing about value investings. It just means that you have to realize in investing you are going up against difficult odds.
Other reasons to be wary of getting advice from others are that their investment style might be flawed. A lot of investors invest based on economic conditions, technical analysis, or on promises of future growth. These styles of investing have historically not performed very well compared to value investing.
In addition, let’s say you do take the advice to buy a specific stock, you are going to own one stock? That is not smart, you need at least several stocks to diversify and reduce the concentration risk. Even if you find the best stock in the world, maybe tomorrow the whole top management will be killed in an airplane crash? Also when do you sell? You get advice about when to buy, but knowing when to sell is equally as important.
For all the above reasons you should take any investment advice with a grain of salt.
Conclusion:
These are many common mistakes investors make when investing. Before learning to invest it is important not to fall into the traps mentioned above, or any other mistakes. Now that you know what not to do, let us focus on what you should do. To start off we must answer a basic question, “what is a stock”?
Disclosure: Long MSFT
http://www.valuewalk.com/
Lesson #4 Do Not Try To Find The Next Microsoft
You might read an article detailing how this stock will be the next Microsoft. I see these ads, and articles all the time. So you read the article and think if I just invest a few thousand in this stock it might be the next Microsoft and I will be a millionaire. Do not buy into this mentality. For every Microsoft, there are dozens if not hundreds of companies that went bankrupt. When you buy these companies what you are doing is really gambling and speculating, not investing. You are hoping that this company will be the next Microsoft. The odds are stacked against you completely. As I like to tell people if you are going to gamble at least go to Vegas and have fun. Benjamin Graham states that the “The most realistic distinction between the Investor and a Speculator is found in their attitude toward stock market movements. The Speculator’s primary interest lies in anticipating and profiting from market fluctuations. The Investor’s primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which they certainly should refrain from buying and probably would be wise to sell”.
Lesson #5 Do Not buy Companies That Have Not Proven Themselves
This lesson is related in many ways to lesson #4. The point here is that do not buy into companies that are losing money on hopes that they will in the future produce profits. New companies that have not proven themselves or earned profits are highly speculative and usually are bad investments. Many of these companies are tech companies that are producing products that will hopefully produce a profit in the future. The problem is that the technology sector is one of the most competitive ones out there. If a company is inventing robotics that will revolutionize household chores, or military tactics there are likely 100 companies with the same exact idea. This is one of the reasons Warren Buffett, and Benjamin Graham hated technology companies. If the company has a strong balance sheet, is producing earnings, and trading at a low valuation the stock might be worth a look. However, a beginning prudent investor would avoid young companies that have no history of profitability.
Lesson #6 Do Not Listen to Stock Tips From Anyone
Unless you happen to be friends with Warren Buffett, it is highly recommended never to listen to stock tips from friends, the media, or anywhere else. It does not matter if the stock is a penny stock, or a blue chip like Wal-Mart. The main reason for this is you have no idea what this person’s track record is. Many of the money managers who appear on CNBC, Bloomberg or other media outlets have less than impressive track records. It is hard to believe, but MOST money managers managing billions of dollars in assets underperform the market index. This means it would be better to buy the Dow Jones ETF instead of investing with these money managers. In fact 80-90% of money managers underperform the index. This is for a simple reason. The stock market is a network of all the money managers, hedge fund managers, individual investors etc. On average the market will return 10% a year. However many mutual funds charge a 1% fee, plus there are many hidden fees which add 1% or more. If you purchase an index fund since it is not actively managed the fees are very low, sometimes even below 0.1%. So on average the index funds will outperform money managers, with far lower risk.
This all does not mean you cannot beat the market, otherwise I would not be writing about value investings. It just means that you have to realize in investing you are going up against difficult odds.
Other reasons to be wary of getting advice from others are that their investment style might be flawed. A lot of investors invest based on economic conditions, technical analysis, or on promises of future growth. These styles of investing have historically not performed very well compared to value investing.
In addition, let’s say you do take the advice to buy a specific stock, you are going to own one stock? That is not smart, you need at least several stocks to diversify and reduce the concentration risk. Even if you find the best stock in the world, maybe tomorrow the whole top management will be killed in an airplane crash? Also when do you sell? You get advice about when to buy, but knowing when to sell is equally as important.
For all the above reasons you should take any investment advice with a grain of salt.
Conclusion:
These are many common mistakes investors make when investing. Before learning to invest it is important not to fall into the traps mentioned above, or any other mistakes. Now that you know what not to do, let us focus on what you should do. To start off we must answer a basic question, “what is a stock”?
Disclosure: Long MSFT
http://www.valuewalk.com/
