My major back in college was finance, but I openly confess that most of what I learned about investing came from the good old school of hard knocks. That seems to be true of nearly everything you do in life. There is the theory in textbooks, then there’s the reality and application of real life. Guess which one wins?
I’m now a staunch advocate of baptism by fire. Only when you get burned do lessons really sink in.
Here are some of the things I’ve learned about investing from my own personal experiences and trials.
1. No Investment is a “Sure Thing”
No matter how confident you are in a certain investment, it’s never a sure thing — no matter what you or anyone else thinks about it. Ironically, the higher your confidence level, the greater the potential for that investment to fail.
Never be so confident of your own opinion about an investment (or even that of the trusted advisor) that you either, buy too much of a given investment, or you fall in love with it along the way.
2. Recognize When Enough is Enough
Knowing the “when enough is enough” advice pertains to investing in much the same way it relates to drinking. Be careful how much money you put into a single investment.
Never overload in a single investment, no matter how good you feel about it. Though this isn’t easy to master — learn when the jig is up on a stock, or even an entire market, and prepare yourself to move on.
3. Avoid Making Emotional Investments
Earlier I mentioned “falling in love with your investments”, which is something that happens all the time. A stock does well for awhile and you develop such confidence in its ability to perform that you actually become attached to it.
At that point, the attachment is more emotional than financial. You’ve learned to feel good about it because it’s become a good performer. But that’s no guarantee of its performance in the future.
If a stock has done well, don’t assume it will rise forever. If news is coming out that there may be problems with the company, it’s better to sell and take profits then to risk losing your gains over some emotional attachment.
4. Don’t Get Greedy
Two emotions control investing — greed and fear. While too much fear can keep you from ever getting rich, excess greed can quickly land you in the poor house. Greed in investing can manifest itself in several ways:
- Excesives emphasis on growth stocks.
- Focusing on a narrow range of investments.
- Overly optimistic expectations of an investment’s performance (for example, expecting it to double or triple in a year).
- Investing to get rich rather than to build wealth.
- Investing in trends rather than in reasonably predictable cash flows.
Successful investing is about patient capital and not get-rich-quick strategies. You are flirting with greed when you pursue the latter.
5. Take Diversification Seriously
In my careers, both in accounting and the mortgage business, I have been in a unique position to see firsthand how many people invest their money. Here’s what I’ve learned: no matter how much we are told to diversify, the majority of people most of their money in the stock market — particularly at or near market tops.
Take diversification seriously, no matter what the market conditions are. A seemingly perpetual bull market is not a reasonable excuse to overload in stocks.
Always have a significant amount of funds in assets that have nothing to do with stocks. E.g. treasury bills, certificates of deposit and even a savings account. When the market reverses — and it will — you’ll be feeling a lot better about yourself.
6. Don’t Quit Your Day Job
Quitting my job isn’t something I’ve done but I know a lot of people who have done it in bull markets. People quit their jobs; either to become day traders or because they are having such a positive run in their portfolios, that they convince themselves they will never have to work again.
That kind of belief usually only lasts until the next market crash hits and reality sets in. Not only do you have to look for a job, but you may need to find a new career.
7. Fund Investors Do Better than Individual Stock Investors
This is a another piece of wisdom gained from my accounting and mortgage experience. There is a consistent pattern where people who invest in funds tend to have positive returns in most years. With individual stock investors, it’s just the opposite. They tend to lose money every year.
I realize that strategy flies in the face of the notion you can beat the market, but the reality is based on the tax returns I’ve seen from hundreds of people. Unless you are a professional, full-time investor, it’s unlikely you will be able to outperform mutual funds and especially index funds — and you can lose a lot of money learning that lesson.
So here’s my summary of investing tips based on life’s experience:
- Keep emotions — especially greed — out of your investment decisions.
- Know when to sell and when as buy.
- Diversify, diversify, diversify! That means outside of stocks too.
- Your primary occupation needs to remain your main focus, since it provides revenue from outside your portfolio, it is also a form of diversification.
- Invest in index funds — you’ll win more and worry less.
Based on your own investing experience, what other financial lessons would you add to this list?