I've found that, more often than not, in the social events that come with the summer months, the conversation at some point moves on to finance and investing.
Unfortunately, a comment that is all too common among other investors I talk to, particularly at family events, is, "I thought it was a good idea to copy the idea," referring to an investment recently made off the back of a recommendation by some famous TV pundit or hedge fund manager.
These statements surprise me, particularly when they come from older investors who should really know better. Copying an investment decision without conducting your own research and analyzing the business in respect to the rest of your investment strategy is a shortcut to making a significant mistake.
Building your own experience
All too often, people view investing from the perspective that everyone is the same and no portfolio should be different to reflect individual circumstances. If one stock is being recommended by Wall Street, it should be suitable for everyone, right?
This couldn't be more incorrect, not just in relation to stocks but also in relation to broader portfolio management strategies. Charlie Munger (Trades, Portfolio) and Warren Buffett (Trades, Portfolio), often reference their circle of competence, which put simply is the limit of their knowledge when it comes to investing.
These are some of the best and most experienced investors in the world, and they know that they will only succeed if they invest in what they understand. Investing outside of your circle of competence leaves you open to mistakes, misunderstanding a development in the industry or sector that may be catastrophic for the company you hold a position in. It also means you have to do extra work to understand what you involved yourself with and how different factors will impact the business.
But it is not just investing in what you know that is important. It is also important to build a portfolio in a way that suits you, a way that suits your lifestyle and what you wish to accomplish with your life.
Building a portfolio for YOU
Equities over the long-term undoubtedly generate a better inflation-adjusted performance for investors.
However, to be able to benefit from the wealth-creating power of equities, you need to be able to tolerate volatility. If you cannot tolerate volatility, then it's more than likely you'll end up selling at the bottom of the market, costing yourself far more than if you had just invested in bonds and accepted the lower returns over your lifetime.
Also, paying attention to your goals and financial objectives is important.
For example, if you are saving for a house in five years' time, buying equities probably isn't the best solution because there is around a 50/50 chance of you being in positive territory in five years. Over 20 years, the risk of loss falls to zero, so if you are saving for retirement then equities are probably the best solution. Saving for a financial obligation in a decade's time may not be sensible.
What I am trying to get out here is the conclusion that investing is not a science -- it is an art. Before you start to paint any picture, you need to know and understand what you want to accomplish, and how you are going to accomplish it. If you don't understand these facts and the best way to achieve the goals you have set out to accomplish, then you are going to make your mission much harder.
Investing is 100% the same. If you don't know what you are buying and selling, not only are you making life harder for yourself, you are also significantly increasing the risk of a severe loss -- a loss that could set you back years in saving.
Even though they may seem like two completely different disciplines, investing and art are very similar. It takes years of practice and experience to become a good artist, and the same is true with investing.
You need to know and understand your skills. Yes, you can copy others, but this does not make you an artist because you will never really understand what makes a good painting. Copy other investors, and you'll never really understand what makes a great investment.
Disclosure: The author owns no stock mentioned.
