There’s often a thought that investing can be broken down to some sort of mathematical equation. But that's not true. Nothing as profitable as investing can ever be that simple. Investing actually involves a large dose of philosophy, and that includes accepting certain truths, whether or not you're ready to face them.
Here are seven investing truths that you need to be aware of.
Apply them to your memory as they're not just ones to remember when you begin investing, but throughout your investing life.
1. No One Can Foresee the Future
This means there's no substitute for discipline when it comes to investing. You have to do solid research before buying any stock or investing in any specific sector fund. Anything less will be relying on dumb luck.
Along the same lines, never assume that anyone else can see the future of investing. Hero worship is just as real when it comes to investing as it is in any other endeavor in life.
Most of us see someone who seems to have a hot hand in picking investments, then presume that he or she has some sort of superior knowledge or inside information. Then we try to follow every recommendation from that investment genius — at least until the picks start blowing up (which they usually do).
If done right, there is no magic involved in successful investing, just a lot of hard work.
2. Not All the Stocks You Pick are Winners
You may come to a point in your investing life when it is you who seems to be the one with the hot hand when it comes to picking winners. Don't fool yourself into thinking that you can't go wrong when picking stocks.
It’s hardly impossible — and not at all unusual — for someone to go through a streak in which most of their investment selections seem to be winners. But never allow yourself to become intoxicated with this idea, or to think that you have the “investment thing” figured out.
Economic conditions change, as do regulatory environments and market directions. It is entirely possible that the reason for your short-term success has to do with the fact that most of your investments were lined up in a way that benefited the dominant trends. But once those trends shift, your hot streak may come to an end and you may not look so smart.
Stay aware of shifting circumstances, and be prepared to adjust as conditions warrant. No matter how long you have been investing, you should always approach it with the mindset of a student and be ready to learn.
3. Trust Your Own Advice Over Other Experts
This gets back to thinking that others have superior knowledge of investing. Just as can happen with you, some investors can go on hot streaks. The ones who are particularly public about their success can seem superhuman. Rest assured that they aren’t.
Always do your homework when it comes to investing, no matter how attractive someone else’s advice may be. As you gain more experience, you’ll find it easier to take the advice of others in more objective way.
4. The Stock Market Is Not Guaranteed
Bull markets, like the one we've been in since 2009, cause a tsunami of projections that will turn almost every investor into a millionaire in just a few years. But while bull markets are common, they hardly represent the entire history of the stock market.
When it comes to investing, it’s important to keep your feet on the ground. Understand that there will be corrections and bear markets — some of them lasting several years — and you’ll have to be prepared not only to live with those markets, but also to be able to invest in them.
This truth means adopting the mindset of a long-term investor, who is prepared to invest in securities and sectors that are likely to weather all but the most extreme market conditions.
5. Transaction Fees Matter
This is one of the major reasons why it is so difficult to make money consistently as a trader. The more you trade, the higher your transaction fees are. It makes a real difference over the long-term.
For example, let’s say you invest $100,000 in an index fund that earns 10% per year over the next 10 years. At the end of that time, your investment will grow to $259,374. But if you're a trader and you're paying an additional 3% per year in transaction fees as a result of your numerous trades, your return will drop to 7%. At the end of 10 years, your investment will grow only to $196,715.
Paying 3% per year in fees may not seem like a lot of money on an annual basis, but over 10 years it can rob you of more than $60,000.
6. Don't Be Afraid to Win, or Lose
This is as much about your emotional adjustment as anything else. No matter how many investments you put into the win column, there will be losers. Nobody has figured out a way to win on 100% of their investment picks, and you won't either.
Celebrate your wins, but be prepared to learn from your losses. More importantly, don't become emotionally attached to your investments. You should be prepared to move on in either case. You can never know what’s coming with your next investment pick.
7. Get Used to Predicting Trends
In #1 I said that no one can foresee the future, and that’s categorically true. But there’s no denying there is an element of fortune-telling when it comes to stocks. You’re attempting to predict the future and how it will impact the performance of the given investment.
In that regard, you're attempting to make a host of predictions — that the economy will remain stable or grow, that the industry won’t face any structural problems, that new technologies won't render the company's products or services obsolete, or that there won’t be any regulatory action taken against either the company for its industry.
That’s a lot of predicting, but there’s no way to get around it. This is why doing research first becomes so important. You can’t just focus strictly on the health of an individual company, but you also have to look at its industry, its competition, its regulatory environment, the economy, and even political or geopolitical circumstances, and make reasonable projections as to how they will impact the company.
Readers: What are some other truths about investing that you've learned, that should be added to this list?