Can you imagine investing in the next big bang idea I come up with if I tell you that you’ll have to pay me money regardless if I make you money or not? I know — you’ll run as fast as you can.
It may sound oxymoronic, but that’s what you are doing when you let your hard-earned money in the hands of so-called pros.
We spend hours scouring the Web when we need a new car, but we seldom know the mutual fund performance or the track record of the fund manager who handles our money.
We feel pride in protecting our house and cars with insurance, but we seldom think about protecting our investment with the same fervor.
Can you ride the bull like a pro? Of course you can! — all you need is the commitment to — purge stereotypical rules of investing constantly regurgitated by the pros from your mind and embrace audacity to apply investment rules that can make you money.
1. Buy high, sell higher.
The common wisdom is to buy low and sell high. After all that’s what Warren Buffett does, right? Although I admire Warren Buffett for his simplicity and investment acumen, he invests his money in preferred shares. He lends money to fortune companies like GE with fixed interest income.
Buying low is akin to catching a falling knife for average investor. Those who invested in AIG, Enron and General Motors at their low have crucified their hard-earned money by following buy low and sell high mantra.
If you blindsided your desire to buy shares of Apple, Google, Bidu, Chipotle Mexcan Grill and many other stalwart investments of the past few years — you have turned a blind eye to an opportunity to grow your money faster than those pros on the street.
Most successful investors know — from the history — that stocks making “new highs” — that is, those reaching price levels not see in a year or more — tend to continue moving higher. Apple has gone up over 400% in last three years.
2. Beware the P/E trap.
One of the biggest myths of investing is the advice to buy low P/E stocks. P/E tells you how much you are paying for every dollar company earns. However, market always looks forward. What you are buying is the right to share in the future earnings. Adding to conundrum, cyclical stocks go through major ups and downs. Dow component Alcoa has returned net loss of 36% for the past year while its P/E ratio has dwarfed in the recent years.
Cisco Systems soared 75,000% from 1990 till 2000. Its P/E during this period was insanely over 40. Cisco has returned negative 5% in the last decade with a reasonable P/E ratio of 15.
You should not put all your eggs in one basket. But, not investing in a stock just because of its high P/E may be robbing you from an incredible opportunity to profit from its explosive growth and subsequent stock advance.
3. Have an exit plan.
Another equally insane idea is to fall into the long-term investment trap. Every investment requires careful planning, including exit strategy. Have you ever considered not buying insurance on your car or home? You don’t buy insurance with the hope to profit from it. You buy insurance to protect your car or home from unexpected loss.
Your other investments require same protection. If you purchased a stock that went down, it’s wiser to take a smaller loss and let your money work on other investment than to sit in the long-term investment camp and to hope and pray that your investment won’t turn its ugly head.
I sold one of my hotels right before Lehman Brothers collapsed in late 2008. I sold it to a buyer for $2.3 million which was less than what I wanted. I did that because the business had already begun its downward spiral. By selling it at $2.3 million, I was still able to make hefty profit. If I had waited for another year thinking that real estate is a safe bet, I’d have made a huge mistake.
Any investment is bad unless it makes you money. Smart investors cut their losses short and deploy their capital to an investment that can make up the loss. Everyone has different appetite for the loss. Nonetheless, you should never invest your hard-earned money unless you know precisely your aim to make certain profit or to take certain loss.
4. Average up not down.
This has always worked for me. You never throw good money after bad. When you average down, you are plowing more money into an investment that has gone against you. You do this with the hope that by bringing average price down, you have a better chance to break even when the stock price will rise. Well, many stocks never rise back from the coffin.
Instead, it is lot easier to buy some shares and watch to see if your investment decision worked in your favor. Then add more to your position as stock advances.
You really don’t have to invest in stocks if that’s not your cup of tea. Nonetheless, You should educate yourself with abundance of resources available to invest wisely in different ETF funds, Vanguard Index Fund or Templeton Growth Fund.
Over the years, I’ve made my shares of investing blunders. But, for the last few years, I’ve taken active interest in constantly learning what works.
My portfolio has returned over 30% for the last few years. And, it’s up again this year. All due to constant learning and applying these investment rules that work.
Take charge of your investments and banish the power of these so-called experts who don’t have your interest at the top of their priority list. It reminds me of Nike’s brilliant marketing slogan — just do it!
Risk comes from not knowing what you’re doing. — Warren Buffett
Thank you for explaining “2. Beware the P/E trap.” – it was riddle’ish to me and your simple example nicely demistified it. I am big fan of simple examples, you did a good job with this one.
Alik, P/E is important but it you can’t rely on it solely to make investment decision. What seems cheap can get cheaper and vice-a-versa. 🙂
Exit plan was my biggest problem (still is whenever I invest in single stocks). I think relatively-passive index fund investing works best for me because I’m not worried about a particular industry or company and am able to spend more time focusing on making money than trying to gain an extra 2% here or there.
Nick, I agree. If investing in equity is not your cup of tea, don’t push yourself just because everyone is chasing the bull. Nonetheless, you should never hand your money to these so-called experts who don’t know any better than the 5th grader. 🙂
The problem with most people is that they decide to go for an investment based on a single factor like P/E ratio. P/E ratio became a blockbuster when Peter Lynch mentioned it in his bestselling book ; “One Up On Wall Street ; I wish people had read the complete book.
Shilpan, your style of writing is impressive. It seems I can not resist becoming a regular reader.
I’m a big fan of Peter Lynch but, a lot has changed since he left Wall street. One has to learn winning ways to make money in the market. Thank you for the compliment about my writing style. I write straight from my heart. 🙂
Great advice. My big problem is having a re-enter plan. I exited some of your examples way too early. I got shaken out, but never had a plan to re-enter. Before I knew it, the ship had sailed way too far from port.
Buck, Here’s what I do. I use chart to decide the entry point once the stock hits the floor or close to it. And sell it as it approaches the ceiling. If stock breaks the ceiling with heavy volume considering that fundamentals are strong(ROE, PEG, cash on hand) then I buy it back at the “new-high”.
Nice tips! I especially like No 3 and 4. Having an exit plan is difficult because it feels wrong to sell an investment when it is doing so well. But that is also how you lock into the earnings. And as for No. 4, we’ve all been sold on the idea of balancing our assets every year. But isn’t that really just throwing the good money after bad? By the way, great job getting 30% returns!
Yes, have you noticed that most experts give advice on when to buy and not when to sell? When we are buying, they are the ones selling to us. 🙂
The Buy High and Sell Higher idea is also called the great fool theory. It is not that I do not do this because I look at stock prices on a relative basis. This can work in a fast rising growth stock.
I do look at P/E ratio, among other ratios. I do not have a set P/E ratio for a stock, but look at this ratio relatively to this history of the stock and relatively to other stocks of the same type. Generally you would want to buy a utility company at a much lower ratio than a growth company.
I do not have an exit plan per se. but sell a stock that is not performing as I would like it to. However, I keep a much closer eye on a growth company or a resource company than I would a utility company.
I never really bought stocks a bit at a time, so I do not average up or down, but buy what I want if the price is reasonable.
There are many ways to skin a cat. So, as a growth stock investor, buy high and sell higher has worked we ll for me. I agree with you that P/E ratio is relative based on the sector, but many investors look at P/E as the only touchstone to decide. And, that can be dangerous.
Again, these rules have returned over 30% for last several years for me. It may not work for someone else.
When I was young and just starting out, I made great returns also. But a return of 30% on a $10,000 investment is $3,000 and is not much money. If you get 30% on a $100,000 you get $30,000. This is nice, but not it is not serious money.
I found that as I went on to build my portfolio my returns got lower. Now I am living off my investments my return is around 7 to 7.5%. My portfolio is increasing at 4% a year and I am taking out 3 to 3.5%. A serious decline in return, but since I have gone through 2 bear markets since stopping work in 1999, I have nothing to complain about.
I must admit that living off my investments I switched to a lot more dividend paying stocks, and away from growth stocks. My dividend yield before stopping working was 2% and it is now 3.5%. However, I also liked dividend paying growth stocks and I still have some of those.
I can’t agree with you more on dividend paying growth stocks. But, I don’t make investment decision solely on that criteria. I’d love to see Apple paying dividend to its shareholders
Also, I have a large sum invested in big cap stocks. 🙂
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I am a value investor not a growth stock investor. Value investing is all about buying the stock in a decent company thats usually unpopular for a great price. Or to put it another way buying the stock in a company thats worth 30 dolars for just 10 dollars.
Growth stock investing is all about buying into the future expectations of a company and how can anyone predict with any degree of certainty what the future will hold for that company. When investing in a hot growth stock ask yourself this what are the odds that the company that you want to buy will grow 20% per year for even five years let alone ten years.