fyi: Worst Things said by New Investors:
Apprenticed Investor: Bite Your Tongue
By Barry Ritholtz
5/17/2005 11:12 AM EDT
These "words of wisdom" reflect poor decision-making on the part of investors. These fables and legends contribute to investment behaviors that can reduce gains or cause big losses. They do not contribute to a person's financial well-being.
If you have ever said -- or even thought -- any of the following, you need to re-examine your investing philosophy: 1. 'I love this company.'
This is the statement that gets investors into more trouble than any other, and here's why: You are not buying a company -- you're buying stock in a company. There's a universe of difference between the two.
Warren Buffett of Berkshire Hathaway (BRK.A:NYSE) buys companies; Cisco Systems (CSCO:Nasdaq) CEO John Chambers buys companies. When Jack Welch was running General Electric (GE:NYSE) , he bought companies. Mere mortals such as you and I -- we only buy stock.
It is arrogance to imagine you are purchasing anything more than a one hundred millionth of an ownership stake (or less) in these firms. The action of that equity is much more important to you as an investor than your personal affections for the entire company.
Microsoft (MSFT:Nasdaq) is a good example of this -- in 2002, you could have paid as much as $35 (postsplit) or as little as $20 per share. It's still the same company, but at the recent price of $26, one buyer is up 30% while the other buyer is down more than 25%. Same company, different entry prices for purchasing the stock.
That's why pricing and timing are so important.
Loving a company will not make up for a bad buy. Unlike VCs and corporate chieftains, we don't get to buy business models. 2. 'I am a long-term investor.'
The most astute thought ever put to paper about this statement was the classic quip by John Maynard Keynes: "In the long run," Lord Keynes said, "we are all dead."
The long dirt-nap aside, being long term does not mean abandoning the responsibility to set reasonable sell triggers on both the upside and the downside. Long-term investors should still review their holdings monthly (if not weekly) for various sell signals.
It's important to listen to what a stock is telling you. The long run is not an excuse for riding profitable positions all the way back down to break-even or worse. I like to use a trailing stop for these types of holdings (i.e., Altria Group (MO:NYSE) or Exxon Mobil (XOM:NYSE) ) to prevent giving back all the hard-won gains.
Consider this: The employees of Lucent (LU:NYSE) and Enron had loaded their own 401(k)s with their respective companies' stock; they thought of themselves as good long-term investors. 3. 'I just heard on CNBC (or CNN or Bloomberg) that...'
This is the kiss of death. Every trading desk in the known universe has CNBC (and CNN or Bloomberg) on in the background. They have screamingly powerful computers and wicked-fast T3 lines. They do this all day, every day. Unless you are among the fastest of the fast, by the time something hits CNBC, it's all over but the crying.
The lower-risk/easy trade is over by the time an item hits the airwaves. The reason it's on TV in the first place is that initial move -- that's what catches the attention of the producers. By the time it hits the financial shows, the news is already "in the stock."
Savvy traders are known to short into any temporary, TV-induced pop.
My head trader is fond of an expression: "Last man in pays for beer." Chasing the latest hyped stock is a sure way to foot the bill for everyone else's drinks. 4. 'I don't want to pay capital gains taxes.'
I consider this to be the single dumbest thing ever said by any investor anywhere. Period.
I cringe each and every time I hear this shockingly ignorant statement. There is simply no worse reason to continue holding a position than to avoid taxes.
Once you've maxed out your tax-deferred accounts, your goal should be to pay all the capital gains taxes you possibly can; lots and lots of 'em.
I'm reminded of an incident from '96: A friend of a friend had a huge position in Iomega (IOM:NYSE) . They owned tens of thousands of shares at an average cost around $5. The stock had split repeatedly, 5 for 4, then 3 for 1, then 2 for 1. This individual was sitting on what was rapidly becoming an institutional-sized position.
I asked when they wanted to sell, and got the classic answer: "Do you know what sort of tax bill that would generate?"
At the time, the stock was skyrocketing. At $50, it went parabolic. I watched this entire move, swearing I would not butt into someone else's trade. Finally, the stock went vertical, with the third exhaustion gap -- a sign that the buying frenzy was peaking. My willpower gave out: I pleaded with them to convince the holder -- not even a client! -- to at least lock in partial profits. "If you're not going to dump all of it, then at least sell half -- for crying out loud, lock in something."
All to no avail.
It's a shame when someone makes a trade of a lifetime and then blows it because of greed. The cliche is true: Bulls make money, bears make money -- pigs get slaughtered. 5. 'I'm waiting for the stock to come back to break-even.'
If you bought a stock which is now underwater, there are likely legions of people waiting for the same break-even point to get out. That's what the technicians mean by "overhead resistance."
In fact, much of technical analysis is based upon the psychology of people waiting to get out of -- or into -- a stock at a previously missed price. When a stock dips and then rallies, those who missed the previous low price wait for another opportunity to buy it there. That why it's called "support," and it's why buyers seem to appear at the same price on a chart in a given stock.
The reverse is true of sellers. Cisco is having a tough time getting through $24; every time it dips, holders kick themselves for missing that sale opportunity.
"If it only goes back to X, I'll sell there" is practically a mantra. Once a stock "breaks out" through that resistance -- preferably on big volume -- the supply of stock is exhausted at that level, and it's clear sailing to the next resistance level.
For Sun Microsystems (SUNW:Nasdaq) that number is $5.50, for EMC (EMC:NYSE) it's $15.50, and for Microsoft it's $30. These levels are the reason why traders follow "breakouts" -- and why some stocks have such trouble returning to your break-even purchase price. 6. 'This stock looks cheap down here.'
Any time you hear this tidbit, you can bet that either 1) the stock just got killed because of some awful news, or 2) it's in the midst of a long and relentless downtrend.
Don't confuse stock price with value. This was especially true in 2001 after all the prior splits. Sun Microsystems (SUNW:Nasdaq) is a perfect example. Monday's closing price of $3.89 may sound inexpensive, but don't forget the five splits between 1995 and 2000; back them out, and the stock is $124.48. Same $13.25 billion dollar cap, but it doesn't sound so cheap minus the splits.
Of course, some stocks do actually get cheap "down here." But it has nothing to do with the numerical price. 7. 'This fund did great last year.'
This is the flip side of "looks cheap down here." It comes up whenever someone is considering putting money into a mutual fund.
It is the investing kiss of death.
Studies have demonstrated that last year's hot fund is this year's loser. The prior year's performance is the single worst indicator of the next year's numbers.
Some funds did well because their niche was hot that year. It could be a region -- last year, it was energy, a few years before that, Russia. Sometimes a sector is the flavor of the month. Defense was recently the darling of the moment.
Funds that represent niches often outperform in some years and badly underperform in others, as the factors leading to their outperformance were aberrational and often unlikely to repeat. That's why chasing last year's news usually results in poor performance.
In September 2002, Bill Gross' Pimco Total Return bond fund passed the Vanguard S&P 500 fund to become the biggest fund in the world. That was an example of investors piling into a "hot" sector and nailing the top of the bond market; it was also a month away from the bottom for equities.
Avoiding funds that did great last year should not be confused with funds that did great "last decade." Good money managers consistently post good results, with low drawdowns and lowered volatility. These managers don't have the aberrational years when they are up and then down huge.
Funds such as these are good places to put your managed money. 8. 'I'm a bull.' (or 'I'm a bear.')
I never understood these dogmatic declarations; investing is not college -- you don't have to declare a major.
Hypothetical question: Your get into your car to run some errands. Are you a "green" or a "red"? Do you make up your mind and simply drive through the next red signal, just because you are a green? Do you come to a dead stop -- regardless of the color of the signal -- because you're a "red"?
It's a ridiculous question. You look at the color of the light and either step on the gas or the brake. The market is the same way -- when market sentiment, valuations and monetary policy are in your favor, you get long. When they are not, your portfolio should be more defensive. 9. 'I don't want to take a loss.'
A variation of "I'm waiting for the stock to come back to break-even," but with a new added factor: self-delusion.
Brace yourself for the bad news: You've already taken the loss. Just because you haven't yet sold, the position is irrelevant.
A key to successful investing is being honest with yourself. By saying they don't want to take a loss, investors are not admitting two things. First, that they made a mistake; they bought something and it went down. Fess up to it.
Secondly -- and this is even more important -- losses are a part of investing. The best stock-picker in the universe buys stocks that go down. That doesn't matter; what does is whether you recognize that reality and have a plan in place to deal with it. 10. 'I got a great stock tip.'
Stock tips are the last refuge of equity scoundrels. It's lazy, irresponsible and just plain foolish.
The plain truth is that the vast majority of "tips" are for horrific little stocks that don't have a snowball's chance in hell of ever amounting to anything -- at least not on a sustainable basis. In fact, many so-called tips are nothing more than the work of stock touts -- paid weasels whose sole job in life is to run up the price of some worthless piece of junk so unscrupulous sellers can exit at a desirable price. The "tip" investor is usually left holding the bag.
Ask yourself the following of all tipsters: What's their motivation? How good is their information? (If it's too good, well, then you shouldn't be using it anyway.) What is their track record?
I never trade on tips, but I have a network of other pros whom I regularly swap ideas with. This is very different than a "tip."
I deal with one trader who knows the gaming sector inside out -- that's his expertise. He's helped make his (and my own) clients a fortune. Another is an analyst (Charlie Wolf of Needham) who covers the PC sector -- he got me into Apple (AAPL:Nasdaq) at the bottom and out of Dell (DELL:Nasdaq) at the top. I sift through Cody Willard's telecom universe for ideas I like, and then run these through my own discipline.
I rely on far too many brilliant people to list them all. But I've tracked these sources for years, and I keep a log of every "tip" I get.
I missed lots of opportunities doing so, but avoided even more dogs. When Doug Kass tried to steer me away from AOL a few years ago at $52, I didn't know his track record well enough to heed his advice. That was 35 points ago; fortunately, I got stopped out for "only" a $3 loss. Had I known this person better, I might have heeded the advice.
But that's part of the game of investing...