Learning how to invest has been one of the most rewarding experiences of my life. I'm grateful that the first investing book that I read was Benjamin Graham's The Intelligent Investor. I'm equally grateful that Morgan Housel was the first investing columnist that I found online. It's hard to imagine two better starting points for a novice investor.
Those early discoveries taught me the fundamentals of investing and gave me the confidence to start. Today, I like to evangelize the importance of investing (and how it changed my life for the better) anytime I can. In the spirit of giving back to an investment community that freely shares data, wisdom and knowledge, here are 10 mistakes, lessons and observations that I've experienced over 10 years of investing:
1. Market Orders Can Be Dangerous
One of my first investments was in a small-cap medical device company: I bought it for $16 per share and the stock promptly rose to $19. This was too much excitement for a new investor like me, so I decided to sell. My total profit: $0.
How?, you may wonder. It was my dopey decision to use a "market" order to sell a thinly-traded small cap stock. This was the equivalent of saying "Sell!" with no preconditions, and in the absence of an immediate buyer, someone more experienced than I was saw the opportunity to say "Sure, I'll buy that stock...for $16 per share." Doh!
2. Limit Orders Can Be Dangerous, Too
I once bought shares in Staples (don't laugh). The stock traded sideways for a while until the company announced news in late August. I didn't like what I heard, so I decided to sell. So did a lot of other people.
This was the ideal time to use a market order: I wanted out and the stock was extremely liquid. Alas, I placed a "limit" order. And another. And another.
My orders weren't filled because the price of the stock was falling faster than I could respond to. My pennywise decision might have netted me a few extra cents per share in the best case, but instead, it cost me big. The final sell order that I placed (it was a market order) was executed for around $14 per share. I could have exited my position for closer to $17 per share.
3. Zero and Infinity Are Important Financial Concepts
My grandfather was a shrewd guy. I asked him what he thought about Ford and GM when the financial crisis was coming to a boil. (The stock of both companies was in the gutter at that time.) He told me, "If you buy an equal amount of both companies, I bet that one of them goes to zero and the other one puts you well ahead."
I didn't invest in either company, but my grandfather's lesson became clear to me as GM fell into bankruptcy and Ford roared out of the recession. Your losses stop when a stock falls to zero, but your gains don't have a ceiling when a stock gains more than 100%. This is the math that keeps solid, diverse portfolios in the black over a long enough timeline.
4. There Are Two Kinds of Fundamental Analysis
A technical analyst will predict where a stock's price will go based on where it has been. It's easy to dismiss this practice as reading the tea leaves, but I don't. Why? Because I do the same thing when I analyze a company's fundamentals.
My way of estimating a company's earnings and expenses is to look at what happened in the past and project those numbers into the future. Sure, earnings and expenses are subject to less emotion than stock prices, but these technical- and fundamental-analysis techniques both rely on using the past to predict the future. Risky business.
Not all fundamental analysts operate this way. The really good ones make it their business to understand a business. They know how trends, cycles and outside forces will impact earnings.
For a good example of fundamental analysis done right, check out Eddy Elfenbein's commentary on Crossing Wall Street.
5. A Great Entry Point May Never Come
I've neglected to buy great companies that were selling at a fair price because I was waiting for a bargain that never came. It's no fun to watch a stock appreciate by 200% before you buy it, but I've done it (even so, those investments worked out well!).
6. "CAPE" Is a Terrible Sell Signal
The cyclically-adjusted price to earnings ratio (CAPE) is a way to smooth out the peaks and valleys in the S&P 500's earnings. This metric (also known as the "Shiller PE") is frequently cited by bearish investors and mocked by bullish ones because it says that the stock market has been overvalued for decades.
Foolishly, I spent years looking at this metric through a bearish lens, hoping that it would tell me when to exit the market. It was a waste of time and money, but not a total loss. Looked at through a bullish leans, I discovered that the Shiller PE is a wonderful tool for predicting stock market returns. (To see the math, check out "The Best Time to Buy Stocks.")
7. Brokerage Executions Are Just As Important as Fees
Say I placed a limit order to buy a stock for no more than $20.00. Capital One Investing would execute that order at $20.00. Vanguard might execute that same order at $19.97, but Fidelity would often execute the order at $19.82. These numbers are hypothetical, but they illustrate my experience with various brokers. The difference of a few cents here and there can add up to hundreds of dollars saved in a year (and thousands of dollars saved in a lifetime). Sites that review brokerages do their readers a disservice when they myopically focus on fees.
8. Buy and Hold, but Don't Buy and Forget
My grandfather bought me shares of stock when I was a minor. My dad was the custodian of the stock, but I guess he put the statements in a drawer and forgot about it. The State of New Jersey seized my shares and put them in their Unclaimed Property Division because there was no account activity.
Maybe one day I'll write about how hellish it was trying to get my money back, but trust me when I tell you, it sucked. This was no fluke occurrence, by the way. Politicians in every state are happy to take your money from you. Don't let them.
9. Consider Investing in Responsive Companies
I write letters to the CEOs of the companies that I'm invested in. Some of those CEOs have written back to me and they have a common distinction: Their companies have greatly outperformed the market. My sample size is too small to prove anything, but it was a fun exercise that may have a deeper meaning.
10. Active Investing Has an Opportunity Cost
If I could rebuild my portfolio from scratch without any tax consequences, I'd put 30% of my money in a small-cap index fund, 30% in a mid-cap index fund, 30% in a large-cap index fund and 10% in an intermediate bond fund. Alas, my portfolio is a Frankenstein-monster of more than 100 individual stocks. Don't get me wrong, I like the companies that I own and my returns have paced (and sometimes exceed) the stock market overall. But, I'm just not as interested in the stock market as I used to be. (Recently, I've been analyzing data to help people avoid products with fake reviews.)
I don't regret the time I've spent researching stocks, but it could have been time spent with people whom I care about. It makes one think. Maybe the greatest investing mistake of all is not investing time in personal relationships. To do so leaves everyone a bit poorer.