Guest Post: The 3 Most Important Things to Remember When Investing
January 19, 2009 by Miranda Marquit
Filed under Finance
Right now, many people are wary about investing. However, now can be a time of great opportunity — if you go about investing in a savvy manner and with a plan. Today, I offer a guest post from Wade Slome, who wrote How I Managed $20,000,000,000 by Age 32, as part of his virtual tour of financial blogs. I think he offers very sound advice — advice that you can use in these tough financial times so that you can prosper in whatever economy you find yourself in:
Invest Objectively – Not Emotionally
Invest objectively and independently, not emotionally. The “average” investor has gotten absolutely destroyed over the last decade in large part due to knee-jerk emotional responses or through greedy, unscrupulous advice from a broker. If you don’t believe me, check out legendary investment guru John Bogle’s study from 1984 – 2002 that showed the average investor underperformed the “do-nothing” index strategy by 10% (PER YEAR)! Besides the excessive fees and trading costs that ate away performance, so many people got sucked into the belief that technology stocks and real estate would go up forever. Unfortunately the stockholders and homeowners subsequently sold (will sell) when everyone else did (does)…at or near the bottom.
Don’t succumb to the bombardment of emotionally charged snippets and advice that are jammed down investors’ throats. There is plenty of respectable journalism out there, just be selective in the information you digest. Stick to those that provide insight – look forward – not to those that sensationalize or merely report current events, as seen through the rear view mirror. If you eat Big Macs and doughnuts all-day, your health will rapidly deteriorate. If you buy this premise, then don’t subject yourself to trashy information either – it will be harmful to your investing health. What investors really need to do is create a disciplined, systematic investment approach through diligent planning. If you don’t have the time or emotional make-up, then commit the time to find a trusted, experienced investment professional, not a brokerage salesman.
Align Time Horizon & Risk Tolerance
Would you use a bus for a drag race? If you decided to move from one home to another, would you ride a bicycle to transport your big-screen TV? Probably not, yet many investors use mismatched strategies and investment vehicles that are inconsistent with their time horizon and risk tolerances. That’s why it’s so important to create a comprehensive investment strategy that takes into account your personal objectives and constraints. What’s more, there is no silver bullet or one-size-fits-all portfolio, so have a process in place that allows you to rebalance your portfolio as market conditions or personal circumstances adjust. If you are in the asset accumulation phase, you are in a position to take on more risk and demand a higher return, whereas a retiree with a limited time horizon and income generation may require a much more conservative portfolio. Each situation is different.
Be Selective When Picking Winning Growth Stocks
In many respects, picking a stock is similar to the process of selecting a college or university. Both decision challenges require a lot of research to arrive at the best outcome (based on the criteria that are important to you). Some schools are more expensive (e.g., private), but may offer higher starting salaries for graduates. On the other hand, some schools are cheaper (public), but offer tremendous educational value and competitive salaries. Regardless of the process, the same discriminating school selection principles apply to stock picking. When determining a style, one investor may be willing to pay a premium price for a company growing above average market rates (“Growth”) while another investor may dig down for discounted bargain stocks (“Value”) that have inferior earnings growth. I am clearly in the “Growth” camp.
Inevitably when the conversation turns to stocks, valuation metrics (i.e., Price-Earnings, Price-Cash Flow, Price-Book ratios) become important considerations. Overpaying for stocks is a risky strategy that often ends badly for the investor. Think about a Harvard student shelling out $35,000 per year in tuition even if the only career aspiration is to flip burgers at McDonalds – not a real cost efficient strategy. However, paying a premium price in some cases makes perfect sense. I consider companies that can sustain earnings and cash flow growth for long periods of time the “gold standard.” In baseball terms, I am much more willing to dip into my wallet to pay extra for a .300 hitter than a .200 hitter on my portfolio team of stocks (NY Yankees, George Steinbrenner approach). I would rather pay a premium for the scarcity value of a good growth stock, than settle for a cheap stock with deteriorating long-term fundamentals.
Market leaders tend to have a competitive advantage — whether in the form of superior research and development, low-cost manufacturing, marketing, and/or other areas in the company — that allows the entity to consistently garner more and more market share from its competitors. These competitive advantages are what allow companies to produce exceptional earnings growth for extended periods of time. Since price movements follow the direction of earnings, superior long-term earnings and cash flow growth will produce exceptional long-term performance. This credo is especially important now with growth stocks on sale (out of favor). The opportunity I currently see for future appreciation in “Growth” stocks is the greatest I’ve seen in my career, and as the market anticipates an economic recovery, I fully expect “Growth” stocks to bounce nicely.
Happy investing to all!
Plan. Invest. Prosper.
Image source: Wade Slome
Beginning mid January through mid February, Wade Slome, author of How I Managed $20,000,000,000 by Age 32 will tour cyber space. You can find him at www.Sidoxia.com. The full tour schedule and details are posted on his Web site. Autographed copies of Wade Slome’s book are available Sidoxia, or you can purchase a book from Amazon.com.
Each time a blog visitor comments on any or all of Wade’s blog stops, they will be entered in a random drawing for a free copy of How I Managed $20,000,000,000 by Age 32. Wade is also offering a free ebook which shares excerpts from his book, for a limited time at www.Sidoxia.com.
This post was very on target and perfectly timed. Now is the time to take advantage of current investment environment so you can better position yourself for the future. By acting proactively you will better yourself in the long-run. So reevaluate your risk tolerance, asset allocation, and time horizon now not when the market is going up.
Thanks for stopping by, B! It is a good time to get in. Never has “buy low, sell high” been so applicable. The stock market is low, so now is the time to buy. Carefully chosen stocks, of course!
The market may be low, but nothing I’ve read says that it’s hit bottom.
Another point that helps stabilize your returns if you buy to sell when it goes up (as opposed to holding it for the long term a la Buffett) is to set a target price and then sell when it’s met. It takes discipline and occasionally you may miss additional run up, but you’re less likely to lose in the long term. At the very least, sell enough to take out your original investment.
Great point, Miki! I like the idea of sticking to a target. Disciplined investing is a good way to find better success — but it means developing a plan and sticking with it.
Right. Long-term commitment—the very skill that’s in such short supply.
If you have motto : “buy low, sell high”, now is the perfect time, but how about uncertainty?
Have you good analysis that next year will be better?
Of course there is uncertainty. Every investment carries risk. And personally, I don’t think that next year is going to be much better — but naturally I could be wrong. It’s impossible to truly predict the market. But I take the long view — 10 years or so. Which mean that if I buy now, while the bargains are good (and assuming I choose fundamentally sound companies that recover) in 7-10 years, it will most likely be a good time to sell. Maybe even sooner. Like Miki, I’d pick a target and sell when it hit that. Of course, one also should pick a target for selling a loss, just in case one has chosen the wrong stock. Since it is always possible to be wrong when investing.