How to be a successful investor: 10 lessons learned from my month of studying the stock market
Here in the United States, debt is a big problem. The cost of living is outpacing the rise in income levels, and as a result, we’re spending too much and saving too little.
The average balance-carrying American owes $15,000 in credit cards, $48,000 in student loans, $27,000 in auto loans and $168,000 in mortgages (source: NerdWallet). Less than half of Americans own stocks, and that includes money in pensions, 401(k) plans, mutual funds, ETFs, and IRAs, and individual stocks.
I’m lucky that I’m in a position to save money. I own stocks and bonds. I have a 401k and an IRA. I have college funds set up for my children. The only debt I have is a car payment. But while I have investment vehicles set up, I wasn’t confident that the investments themselves were the right ones for me and my family.
That’s why this month, I dove into the world of Wall Street and gave myself a crash course in investing.
I enjoyed my studies immensely, but throughout the month I found myself struggling to blog about my insights. The stock market is hardly a sexy topic to write about, and any attempt to impart my rudimentary financial knowledge felt silly. But it’s the end of the month and I’ve got to wrap it up, so the best I can do is share the 10 most interesting things that I took away as a result of this project.
10. If you’re not willing to do the homework, stay out of the stock market.
“It is highly unlikely you can beat the market. It is so rare that it’s like looking for a needle in a haystack,” says Burton Malkiel, author of A Random Walk Down Wall Street, who after reviewing the performance of all the equity mutual funds from 1970 through 2013, concluded that it is statistically unlikely for an individual investor to select equities or funds that will consistently outperform their benchmarks.
Former Fidelity Magellan fund manager Peter Lynch, however, maintains that the stock market “isn’t a gamble as long as you pick solid companies that you think will do well.” It comes with a caveat: if you’re not willing or able to put in the time to study the company, its story, its numbers, and its competition in detail, then you should absolutely stay away from individual stocks. Instead, do as Malkiel says and buy the haystack itself, aka the index funds, which is always a good investing strategy.
9. The best investors have a true understanding of risk – they know when to take it and when to avoid it.
Successful investors know how much they’re willing to lose to make a dollar, and they take a host of factors into account including market risks, economic risks, political changes, the impact of rising or falling interest rates, asset allocation and credit risk. They know too that there are many variables that can’t be predicted.
That’s why asset allocation is just as important as security selection and timing. We have to protect our downside with a properly diversified mix of asset classes.
8. Warren Buffett is the best value investor out there.
If you invested $1,000 with Warren Buffett in 1956, you would have over $300 million today. He looks for companies whose “value” is significantly greater than their price, and he is incredibly good at playing the arbitrage game between those two factors. But where we might buy shares of a company we think are priced well, Buffet will (more often than not) buy the whole thing.
7. Don’t underestimate the power of compound interest.
It’s the only time when 5+5 can equal 11 because your interest is reinvested into your investment. Albert Einstein described compound interest as the “greatest mathematical discovery of all time.” According to the rule of 72, if you divide your rate of return (as a percentage) into 72, that is the number of years required to double your investment. It’s no wonder investors place such a heavy emphasis on growth rates when evaluating a stock.
6. Learn how to read and interpret financial statements and ratios.
The only way to determine whether or not a company is a good buy is to understand their fundamentals; i.e. their cash and debt structure, the number of shares outstanding, institutional ownership, revenue, sources of revenue and growth rates, inventories, accounts payable, p/e multiples and more. It’s a cumbersome task, but the digging needs to be done.
5. Buy what you know.
Years ago I bought Lucent (now Alcatel Lucent) because someone told me to. I had no idea what it did. I still don’t. I lost money with that one.
The moral of the story? Stay within your circle of understanding. Don’t rely on past performance charts, hot tips, and one-off analyst opinions to make a decision if you don’t fully understand the company you’re buying and why you’re buying it.
4. Don’t ignore the boring companies.
It’s tempting to flock to the Facebooks and Apples of the world. They’re fast growers, insanely popular and everyone talks about them. But boring companies, the ones that make bottle caps or nail clippers or machines that remove grease from cars, can make for great buys. When no one pays attention to a stock, you have more time to purchase it at a discount, before the rest of the world catches on. Unglamorous companies are also often the things we use every day, even in a recession, like razorblades and laundry detergent. And the good ones have a solid balance sheet, continue to grow, and pay dividends.
3. Invest regularly.
Regardless of whether you’re investing in index funds or a handpicked basket of individual stocks, invest on a regular schedule. It’s the “pay yourself first” theory in practice. It’s okay to buy a stock at $13, for example, and again at $17, $24 and $26, so long as you’re confident in the strength of its fundamentals. For the individual investor, it’s better than trying to time the market.
2. Be patient.
Us non-professionals can’t afford to be greedy, impatient and lazy. We need to have patience to do the research, patience to wait for the right time to buy the right company at the right price, and patience to hold that security for a long, long time.
1. And the most interesting thing I have to say about investing and the stock market…
…is that writing an article about investing and the stock market is not very interesting at all.
Actually, it’s easy to write about the do’s and don’ts of trading. The hard part – the really hard part – is knowing when to end the research and analysis and buy the stock, knowing that there is so much that you don’t and can’t know. The randomness, unpredictability and lack of complete information is a very scary thing.
It’s why I haven’t pulled the trigger on any stock. I’m too overwhelmed and I’m lacking in confidence, but I’m determined to keep at it. Fund manager Seth Klarman sums up the craziness quite perfectly, so I’ll close now with it:
“Investing is hard work — painstaking, relentless, and at times confounding. Separating relevant signal from noise can be especially difficult. Endless patience, great discipline, and steely resolve are required. Nothing you do will guarantee success, though you can tilt the odds significantly in your favor by having the right philosophy, mindset, process, team, clients, and culture. Getting those six things right is just about everything.”