Don’t Make Assumptions. Find the courage to ask
questions and to express what you really want.
Communicate with others as clearly as you can to avoid
misunderstandings, sadness and drama. With just this
one agreement, you can completely transform your life.
—MIGUEL ANGEL RUIZ
Before we get started and dig into the fundamentals of a company and the psyche of investors, it is important to discuss a few of the basic assumptions and risks of investing. If you are new to investing and have never considered taking control of your own portfolio until now, then first off, congratulations, but second, you probably have a long list of concerns regarding this decision. Earlier I called this decision an overly emotional period in a person’s life. The reason that it is overly emotional is that we psych ourselves out in preparation and are sometimes scared before we even start because of what we have been taught to believe about investing.
To this day, one of my biggest shortcomings is my desire to predict or make assumptions about the market. This can be due to one of two things: either overconfidence or a lack of confidence. In a later chapter I will talk in detail about assumptions and behavioral characteristics that cause problems, but for now, you should know that these assumptions are what usually cause trouble for investors. Because we are human, though, assumptions are a part of our personality, therefore making them nearly impossible to consistently avoid. Before we get started, let’s take some time to discuss some of the most common misconceptions about investing so that you can continue with a clear train of thought and open yourself to the notion that you can be successful in this “new era” of trading, even if others tell you that you cannot.
One of the most significant reasons we make investment mistakes is because we set unrealistic goals, seek complexity, and make assumptions that simply aren’t true. In 2007, my attitude toward investing began to change. I had always shown an interest in behavioral finance, but in 2007 I considered myself successful and felt comfortable enough to begin giving advice and talking to other investors and prospective investors. The first thing I noticed when talking to both new investors and people who wanted to manage their own portfolios is that there are several assumptions that underlie investing. I noticed that people really look up to others who work in the financial field and believe that market success is a magic trick of some sort.
I’ve identified five key assumptions to investing that almost all prospective investors believe. If you are a new investor, then you may believe one of these assumptions, but separating from the belief is one of the first steps in becoming a logical thinking, successful value investor.
Before I began investing, I believed that active investors had to be considerably wealthy. This belief was the result of several factors, including how I was treated when I spoke to financial advisors and even the people I knew who were active investors. When I first began investing, I had less than $10,000, which is a fact that people are very surprised to hear when they speak with me. The truth is that I started small, made good investments, made several sacrifices to my lifestyle, and continued to work hard and add money to my portfolio over a period of many years.
Almost everyone who has achieved wealth had to start small. Whether they started with a small business and grew it into a multibillion-dollar corporation or had a good idea and capitalized on that idea, they started off at the bottom and had to work their way to the top. Obviously, this excludes “trust-fund babies” and people who hit the lottery, but anyone with a genuine talent or a level of skill had to work for their wealth. Unfortunately, a major misconception of investing is that the majority of investors are wealthy. According to Fidelity, the average 401(k) balance was $71,500 at the end of 2010, which was a 10-year high. This average is compiled from a participant base of 11 million accounts. And although there are many factors involved, such as age, profession, employment length, and so on, this still puts an end to the assumption that all investors are wealthy. In fact, most are everyday people who make up the “99 percent.” This belief that you must be wealthy to be an investor is simply not true, with the average portfolio, according to Fidelity, being less than $75,000, and this is, of course, dependent on age and years in the workforce.
The misconception and belief that all active investors are wealthy actually hinders some people from learning and asking questions. Our society is very intimidated by those who have wealth. It forces us to be jealous and make bad decisions, but more important, a lack of wealth causes us to feel inferior. Unfortunately, our society does not judge people on their personality, kindness, or loyalty, but rather associates a person with their worldly possessions.
Most people would rather not ask questions than take the chance of feeling embarrassed. I remember when I was 18 years old. I had a balance in my bank account of $3.51. I knew I had a charge that was going to cause my account to be negative, but I couldn’t force myself to deposit enough money to cover the charge. I needed to deposit $7 to cover the charge, but I only had $20 in cash and didn’t get paid for two more days. I had investments but wasn’t able to access the money in the time that I needed. Therefore, I was faced with a dilemma: I could either deposit the $7 to avoid an overcharge, or I could limit the embarrassment and take my chances. Like a moron, I took my chances and was too embarrassed to approach the teller with a deposit slip for $7.
My story may be funny to look back on, but it’s a good example of the choices and feelings that a lack of financial security can cause in a person’s life. I ended up with a $30 overdraft fee because I did not want to approach a teller with a $7 deposit slip. The truth is that most tellers have seen it all. Most likely I could have deposited $3, and the teller would have had a lower deposit at some point during his or her career. This fear is a reality for most people, and it causes us to make stupid decisions when faced with a situation where someone else knows our financial status.
The assumption that all active investors are wealthy has several psychological effects that potential investors must overcome before they can better themselves. The idea that someone else may know your financial status is scary to some people, and for some, who are forced to seek help on occasion, it’s demoralizing. But you shouldn’t let fear of rejection affect your willingness to learn and act in a way that could benefit your financial future. There are a number of intelligent individuals in the financial industry who can help to educate you on building a better financial future, but you must be willing to talk and open up your deepest secret, which is your financial status. You may get some who turn you down or treat you badly, but I guarantee that such a stance will help you in the long run. You can start investing with whatever you want, and it doesn’t have to be a million dollars. The truth is that very few people have a million dollars, and most started off small, even in the prideful world of investing. It is nothing more than a misconception that all active investors are rich. Most are just like you and have had the same fears and misgivings, but they acted on the fears and are now bettering themselves, regardless of what some teller thinks.
The assumption that investing is too complex could be made a reality very easily. The good thing about investing is that it can be as easy or as difficult as you please. There are some people who want to appear most intelligent, and they choose to use complex systems for selecting investments. The people who choose to find a needle in a haystack are defensive and irrational toward those who simply go and get a new needle. Both require work, but the end result is the same—both parties get their needle.
This complexity assumption includes the belief that the more research you perform, the better return you will get on your investment. My belief is that you need due diligence, you need to know your goals, and you need to understand fundamental research, but you also need to know what’s most important to the market. If you research for three weeks and arrive at a conclusion and I research for three hours and determine that I am going to purchase the same stock, does the difference really matter? The idea that research is not required is ignorant. However, I am living proof that you can build your own system based on value investing and behavioral finance and make a significant amount of money in this market. There are hundreds of fast-growing companies that are traded on one of the large exchanges. But the level of return is going to be determined by when you purchase a particular stock, which I believe is the most important area of research and is determined simply by understanding the behavior of the market.
The phrase, “Pick and choose your battles,” is very important in the field of investing. This relates to every aspect of investing: how you feel about a particular company, when to buy, research, fundamentals, technicals, and so on. People have all sorts of different preferences when it comes to the best way to invest. Some focus more on the fundamentals, which means to base an investment decision on the growth of the company, its industry’s growth, and other pieces of measurable data. Then there are others who focus mostly on technical indicators, which means they base investing decisions on charts. These people watch for certain trends to occur. They pay attention to the many indicators that tell them when a stock is oversold, or they may watch for changes in volume. I believe the best choice by far is to invest purely on fundamentals, but then incorporate the behavior and value of the market to find the perfect entry point.
There are over 1,700 publically traded companies that have more than 500,000 shares traded per day. Obviously, I don’t believe that each of these stocks would make good investments, but obviously, some would disagree. Remember, investing is very emotional, and every company has a number of investors who buy its stock. Therefore, this proves that all research is different, and there are numerous ways for an investor to arrive at different conclusions. I don’t think there is one standard way to invest, but I chose a form of value investing that involves limiting emotion, finding companies with solid fundamentals, and then entering at a cheap price. As a result, I do not believe that complex systems are needed to be a successful investor, but I also believe that complex systems are common and are used as a way of showing one’s knowledge.
One of the hardest assumptions to overcome is the feeling of inadequacy or the idea that you are incapable of becoming a personal investor. Regardless of the strategy employed, some people become so heavily reliant on their brokers that they can’t mentally break free. The reasons for not taking control are limitless, but one of the more common ones that I hear has to do with the broker-client relationship.
An investor can have a genuinely strong relationship with the person who handles his money. It makes sense. If money is one of the more important aspects of your life and you are trusting it to a particular person, then you better have a good relationship. The relationship is positive unless it begins to cloud your judgment, such as with my friend Tara.
Most excuses that people provide to defend their lack of action relates to a loyalty of some sort to their financial advisor or broker. But you only live once, and when you are dealing with your hard-earned retirement money, it’s too important to let emotional attachments be involved. You must make the decisions that are best for you and your family, even though, of course, your advisor wants you to stay. He is probably pocketing 4 percent of every transaction on your behalf. The bottom line is that you can do it yourself, and it will cost much less—and the rewards most likely will be greater.
I am often told that the buy-and-hold strategy is dead and that investors are no longer satisfied with a 15 percent return. First, I disagree with the buy-and-hold strategy being dead, but I agree that investors are no longer satisfied with minimum returns. Thanks to technology, our society wants instant results and shows a genuine lack of patience. This lack of patience is often seen in equity markets as the perfect combination of volatility, money, and emotion that creates the most illogical reactions known to humankind. As a result, people labor under the assumption that the markets are too risky and that the only way to make money in the markets is to take a large number of risks.
The idea that you must take significant risks to succeed is highly inaccurate. With every investment comes a level of risk. No matter what you buy, there is risk. In equity markets, the significant risk exists for swing and day traders, but not necessarily for people who have long-term goals or can afford and are willing to endure some bad days for a large return. Investors who day trade or have only short-term goals in mind usually end up achieving a much smaller return than those who hold for an extended amount of time.
I have never considered myself a short- or long-term investor but rather an opportunist. I won’t sell until the price I set is reached, unless something unexpected occurs that changes the business of the company. I don’t panic or react to the market’s day-to-day movement, which is the opposite of short-term traders, who panic the first day their stock trades lower. Then, because of commission costs and too many days of loss, these investors almost always return a much smaller gain.
It’s the most uneasy feeling in the world to watch $3,000 disappear. But if you invest, the chances are that there will come a day when a stock you own will either fall by a large margin or you will wait and take profits too late and lose out on a potentially larger return. However, such days are limited, and by using the tools in this book successfully, you can buy good companies low and sell high while limiting risk, which is the ultimate goal of investing.
I hate the excuse of not having time to become a self-sufficient investor because I don’t understand what is more important than your future. The level of involvement that you allow for your portfolio doesn’t necessarily determine the level of your gains per year. However, successful investing does require time—but not as much as you may think.
Throughout the remainder of this book I will discuss a number of strategies and ways to buy and sell stocks that require minimal involvement but return the maximum level of reward. In fact, some may argue that investors who are too active actually perform worse because they have trouble taking profit as a result of always wanting more and are quick to react when faced with the fear of loss. I do feel that being a value investor will provide you with the maximum level of gains because of the characteristics that I describe, which include staying calm.
The most obvious risk of investing is that you will lose all your money. This idea of risk is a misconception. Obviously, there is a level of risk for any investor, but that level is nowhere near what the general public believes, people who insist that money managers and Wall Street types control all the wealth and take it from the little people. I can’t count how many times someone has said to me that she doesn’t understand why I invest because it’s too risky. The truth is quite the contrary because risk and investing do go hand in hand, but what’s great about investing is that you can limit your risk by having realistic expectations.
If your goal is to return 300 percent per year for 10 years, then chances are that you’re taking some massive risks. The first thing to consider and understand is that investing is not gambling. You are not playing blackjack, betting on horses, or playing the slot machines and praying that it hits a triple jackpot. Rather, you are owning a piece of a company that you believe will grow.
There are many different ways to invest, and if your goal is to limit the risk, then chances are that you will want to invest for value and in companies that return capital to their investors in dividends. In my opinion, risk assessment is something that must be decided on by individual investors along with their families. If you are a 50-year-old man who is nearing retirement, then you probably don’t want to take too many risks on companies that aren’t yet established.
One of the best ways to protect yourself from loss is to have a portfolio that consists of a variety of investments. As we get older, our willingness to take risk should diminish, and our concentration should turn to maintenance while still returning a gain that is better than the norm.
In today’s volatile market, some people are weary of investing in equities. There have been a large number of events over the last 15 years to create pessimism in equity markets. We’ve had a housing crisis that destroyed the value of large banks, along with a dot-com bubble burst that also resulted in a massive hit to the market. These two examples are not reasons to avoid U.S. equity markets but rather be smarter and more realistic and realize that we are in a new era. Success in the market can be achieved, but it’s a different game than it was in the 1980s and 1990s, an era that I call the bull era.
The bull era was a period in time where the economy was booming, consumers were buying, and the markets were trading higher. During a period of 20 years, from 1980 to 2000, the Dow Jones Industrial Average rose from around 850 to greater than 11,500. The terms bull and bear refer to the direction and outlook of the market. When it’s trading higher with a positive outlook, we refer to it as a bull market. But when the market is trading lower and there are rising concerns, we refer to it as a bear market. Obviously, because of the market’s large returns prior to the year 2000, we can say with certainty that it was indeed a bull market. Yet, because of the bull era and the market’s flat performance over the last 13 years, some have left equity markets for investments they consider to be safer and less volatile.
A popular choice for individuals nearing retirement is to invest their hard-earned money in saving accounts or bonds. I have no problem with investors deciding to invest a portion of their savings in these two investments, but I believe that the reason these choices are so popular among near retirees is that such people are unaware of the safer options and larger rewards that are available in equity markets.
Ultimately, it is the decision of you and your families as to how to invest your money. I believe that at this moment, because of fear and recent economic events, U.S. equity markets present the greatest value compared with commodities, global exchanges, or any bonds. People simply don’t realize the value within the market, which is why I am going to spend the rest of this book looking at, defining, and finding value, and the reasons for that value, in the market.