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Isn’t it nice to hear some reassurance during a recession? Especially when the headlines have been doom-and-gloom for months. And it’s true, we’ll weather this storm, just like we’ve weathered every other recession for the past 80 years. If you’re a long-term investor, your portfolio will recover.

You don’t have to take my word for it, I wouldn’t throw that kind of statement out there without providing you with some history and data to back it up. Hopefully this article will help you get some untroubled sleep tonight.

Don’t believe the hype…
The major media outlets are doing what they do best, painting this as the worst disaster in US history. Why? Because it sells papers, draws television viewers and attracts mouse clicks. The scarier the headline and the more dire the prediction, the more successful the story. Thirty years ago, we would have condemned any news journalist that used these kinds of irresponsible scare-tactics. Today, the news is forced to compete with other forms of media, so the line between news and entertainment has become very blurry. As a result, we’ve become accustomed to outrageous (often ridiculous) predictions of disaster and worst-case scenario analysis from people that we consider to be “newscasters” and “analysts”.

We’ve all become a bit more cynical when it comes to the media, but it still takes a toll when all you see for months are predictions of disaster. We see our portfolios taking a beating, and this puts that little nagging doubt in the back of our mind… “could everything they’re saying be true? Is this the beginning of a 10 year global depression?” To compound the problem, it’s human nature to try to one-up the competition. The negativity feeds on itself, today’s headline is always going to be worse than yesterday’s until the economy and the market start to recover.

Take heart…
Mass media is an EXTREMELY poor predictor of future events. What happened yesterday and what’s happening right now is the focus, the media is reactionary so you can count on the forecasts to always lag the actual market recovery. Take a little of Warren Buffett’s advice to heart, “attempt to be fearful when others are greedy and to be greedy only when others are fearful.” If the media is crying that we’re on the brink of total collapse… buy.

Stay objective…
People are fleeing the market in droves, financial institutions are imploding left and right, we’re embroiled in two costly wars, the dollar is weakening and inflation is much higher than it’s been for a long time, right? I don’t disagree with any of those statements, they’re all facts.

How can I say things aren’t so bad if I agree that all of those things are true? Because this is a recession, and things are always tough in a recession so I see no reason why this one would be any different. This is an inevitable part of the business cycle, albeit the most painful part. Every economic boom requires a bust at the end before the cycle can start over and we can experience the next expansionary phase.

But isn’t this worse than all past recessions? Nope, it’s milder than some and worse than others but it’s far from the worst. It only feels that way because you’re losing money. Stay objective, and when you start having doubts, let history be your guide.

So how about some history… when have Americans faced greater challenges?

~ Our worst economic disaster was the crash of 1929. Back then, we were an emerging market. Ever own an emerging market stock? They define the word volatility. The crash of ‘29 and the 10 year depression that followed were dark times in America for the rich, poor, and everyone in between. In contrast, today we are the most developed economy in the world and we have sound fiscal and monetary policies, which is why our expansion periods (bull markets) are so much longer than our contractions (market corrections and recessions).

~ The 2000-2002 Tech Wreck was scarier than this recession. The scariest part of the tech wreck for me occurred right before the crash. Do you remember the euphoria in 1999 and early 2000 near the end of the greatest expansion that the US stock market had ever experienced? Pundits claimed that the tech boom created a new paradigm in business, “we would never have to experience another recession again because of the exponential growth potential of technology companies”. That sounded like complete insanity to me and the crash that followed proved that people often lose their objectivity during strongly bearish AND strongly bullish conditions.

~ 9/11 was scarier than this recession. Prior to 9/11, most Americans spent very little time worrying about our national security. Terrible things happened in other places, they didn’t happen here at home. On that fateful day, we were introduced to terrorism on an unprecedented scale and it happened on American soil. Our illusions of complete security at home were shattered in an instant and the market plummeted. At the time, we had no idea how deep or painful the economic and political fallout that followed might be. The fact that the market recovered only a few months later is a testament to America’s will and resilience.

~ Black Monday was scarier than this recession. On a random Monday in 1987, the stock market experienced its worst one day drop in history, it plummeted over 20% in a single day. I doubt many brokers, serious investors or retirees living off of their portfolio slept well (or at all) that night. There was no logical explanation for what happened, and to this day, people still argue over the cause of the crash (for the record, I blame program trading!). Nerves were frayed for months afterward and market volatility reached unprecedented new highs as investors jumped in and out of the market trying to avoid being part of the next massive selloff.

~ Stagflation in the 70’s was scarier than this recession. Stagflation was baffling for investors and economists when it first occurred in the 1970’s. How could we be experiencing stifling inflation while we were also experiencing a prolonged recession? Theorists worried that recession coupled with inflation could only lead to one logical conclusion, a complete economic meltdown. At the time, there was no historical data to refute that conclusion. Of course, that didn’t happen, but it sure created scary market and economic conditions for several years.

Those examples may have provided a little comfort but, personally, hearing how things could be worse never really makes me feel better. I’d rather hear why things aren’t as bad as they seem, so here are a few historical investing facts that help me sleep like a baby…

~ Every 10 year period since the end of the depression has produced gains. This is even true RIGHT NOW. That’s right, even though we have the current recession and the tech wreck of 2000-2002 lumped into the mix, diversified long-term investors (such as those holding S&P 500 Index Funds) from 1998-2008 have a gain.

~ In the last recession, we faced an INVESTING bubble which created a valuation crisis. Since I’m an investor rather than a real-estate speculator, I’ll take a housing bubble over an investing bubble any day. When the tech boom ended in 2000, every major index was sitting at a record high and stock valuations were through the roof. We were facing a valuation abyss, most stocks in the technology-laden NASDAQ were trading FAR above normal or realistic P/E ratios. We had a long way to fall back then, but we are in a very different position today. Did you know that the S&P had barely made it back to the levels of the late 90’s before this recession started? We don’t have that monkey on our back this time around, stocks are already starting to look pretty cheap from a valuation perspective, even to the bearish pessimists.

~ Today we are facing a HOUSING bubble, but comparisons are starting to overshadow losses. The major banks are experiencing massive losses as a result of questionable speculation and sloppy sub prime lending. What we have working in our favor is that comparisons are starting to look pretty good. The largest bank (no longer the largest) suffered a $10 Billion loss in Q4 ‘07 and a $5 Billion loss in Q1 ‘08. Analysts predicted that they would lose $3.1 Billion for Q2 but they beat expectations by only losing $2.5 Billion. In the last six days, the stock has gone up 43%. Wait! After announcing a $2.5 Billion loss the stock is UP? Comparisons are powerful and the media will almost always focus on recent performance, they rarely look further back than a year.

~ First Movers are starting to pour money back into the market. The financial sector has been beaten down the worst during this recession, and many companies are simply suffering from guilt by association. However, those that weren’t involved in the worst of the risky speculation or sloppy sub-prime lending are now being rewarded. For example, JP Morgan has had decent volume for a couple of months and their stock price is almost back to break-even for the year. First movers are snapping up the best bargains.

Bottom line, this recession will inevitably end just like those that came before it.
I’m not an oracle or an expert, and I have no idea when this recession will end, but I still feel comfortable telling you that “everything’s going to be okay”. The market can’t always go up, it needs cooling off periods. The cooling off periods that are particularly steep, prolonged and painful are called recessions. We’re experiencing one right now, but it’s not the first or the worst and it won’t be the last.

Stay objective, stick to your long-term investing strategy, and ignore the headlines and short-term market volatility. Buy and hold… and hold… and hold… and in the future, when you’re reading euphoric predictions of never-ending bull markets or dire predictions of decade-long global depressions, trust history, if you’re a long-term investor, your portfolio will recover.

Thank you for reading! Please share your thoughts in the comment section below.
~ Odd Lot

Welcome to Millionaire Maker weekly where I review one reader profile or answer one reader question every week. If you like this article and want to see more like it, you’ll find a treasure trove of outstanding money saving tips, effective debt reduction strategies and great investing advice in our Millionaire Maker archives in the column to the right. Click this link to submit your profile or question to be included in next week’s Millionaire Maker Weekly. - Odd Lot

This Week:   Samuel asks, “Will bank stocks ever recover? I hold some shares of C and BAC. I can wait 30 years for them to turn around, it’s no rush, I was just wondering if you think banks are going to recover.”

Yes, they will recover, especially if you own one of the better banks that wasn’t hammered by huge sub-prime write-offs or involved in the CDO speculation circus. The best example is probably JP Morgan Chase, they are eating some mortgage losses, but compared to many of the other major financial institutions, they’re in great shape because they weren’t taking the nutty gambles that their competitors were taking. Banks like this, whose stock prices are down from guilt-by-association will likely recover in less than five years.

Even some of the banks getting battered the worst, such as Citi, will eventually recover but it will take longer. The only stocks you’d have to worry about never recovering are those that are small enough to get into the kind of trouble that Bear Stearns experienced in which they had to either sell out or file bankruptcy because they couldn’t meet their capital requirements.

Why am I confident that the major banks will recover? Because the losses are slowly and painfully working their way through the system, and no recession lasts forever despite the doom and gloom you may see on the news. Eventually, comparisons will start looking pretty good even if the economy isn’t out of the woods. When that happens, the smart first movers will pour money into the market and the next bull rally will be on.

This would probably make more sense with an example… Citi’s comparisons will eventually look good even if they’re still losing money. They lost $10+ Billion in the 4th quarter of 2007 when they moved losses onto the balance sheet, experienced another huge loss in Q1 ‘08 and it sounds like they’re going to take another beating in Q2 ‘08.

Now, fast forward and let’s assume that when Q3 rolls around they lose $1 Billion. If they’ve had multibillion dollar losses for three quarters in a row and the stock has plummeted by about 70% (currently down from $55 June ‘07 to $17 today), a $1 Billion loss actually sounds pretty good by comparison. The stock will start to look like a very good deal to value investors. They’ll jump in and be followed by a lot of institutional investors and you’ll see the stock price head back up toward historical ranges… might take a while to get there though, Samuel, so it’s a good thing you have a long investing time horizon.

If you’re looking for a low-maintenance passive strategy so that you don’t have to sweat this stuff you should probably give Index Investing a look. You can learn more about this and other popular investing strategies in my Complete Guide to Index Investing or my Investing Strategy Review Guides.

I hope some of this information helps you, Samuel. My advice, buy-and-hold-and-hold-and-hold-and-hold…. and then retire wealthy.  I (and I’m sure all of our readers too) wish you the best of luck! Please check back in every now and then to tell us how you’re doing.

Best of luck and please add your thoughts to this post, we’ll all benefit from your questions and insights.
~ Odd

Welcome to my 2008 Online Broker Ratings. All of the major online brokerages are ranked across 6 categories; Overall Trading Experience, Web Site Functionality, Trading Costs and Fees, Customer Service, Research & Investing Tools and Perks. There is also a detailed review link for each if you want to read an article that summarizes all of my findings about your favorite brokerage.

Why in the world would I put so much time and energy into this article? I was looking for a new brokerage. Sadly, all of my research convinced me to stick with my current broker which made this an exercise in futility. However, I gathered a TON of information so hopefully this will help you if you’re currently looking for a great online brokerage or trying to avoid a bad one. Enjoy!
~ Odd

* Schwab was awarded a bonus in the Trading Costs category for having the most No-Fee & No-Load Mutual Funds available
* SoGoTrade was penalized in the expense category for not offering any Mutual Funds, Options, Bonds, Treasuries or CDs
* Zecco was penalized in the expense category for charging for basic services such as Charts ($5 per mo), Stock Screeners ($5 per mo), and Streaming Quotes ($8 per mo)

For some reason, when I woke up this morning, I couldn’t stop thinking about the principles that drive people, particularly those related to personal finance and investing. It’s fascinating to me that there are so many different approaches that can all wind up leading to the same place, prosperity. That is the goal for most of us, right? I don’t really think of wealth in terms of acquiring assets. For me, the goal of long-term wealth building is an overall state of abundance, security, and happiness and I think that’s probably true for many people.

When an idea gets its hooks in me I have to get it out of my head onto paper or I won’t be able to concentrate on anything else, so today let’s talk about The Basic Principles of Personal Finance and Investing.

Anyone that is serious about managing their money well and planning for the future has a set of principles that guide their behavior. This doesn’t mean that they carry around a list that they refer to every time they’re about to make a purchase or an investment. In fact, most successful long-term wealth builders would probably have trouble putting their personal finance and investing principles into words.

Some wealth builders follow a set of beliefs and behaviors that are so ingrained and that they’ve been adhering to for so long that they no longer have to think about them. For this lucky group of people, building wealth comes as naturally as breathing. At the opposite end of the spectrum are those that actually keep a list. Usually the list consists of personal finance and investing wisdom that they’ve accumulated over the years and that they review on occasion to make sure they’re still on track. These examples are extreme, most wealth builders fall somewhere in between. You have to be pretty anal to keep an updated list of your investing and personal finance principles… and yes, I have a list. I guess if I’m confessing I might as well admit the whole truth, I actually have TWO lists.

I thought that today I would share my lists in the hopes that you will add a few of your own principles or expand on mine in the comment section. Below are the 10 Investing Principles and 10 Personal Finance Principles that I adhere to. These lists aren’t meant to contain every important concept, only those principles that I feel are critical to success. I wanted to keep this post relatively short, so every item on the list is a link to an article that will give you a much more detailed description. If you want to discuss any particular principle or if you want to add ideas, please post here rather than on one of the link pages so that everyone can benefit from your insight.

Since I spend a lot of time giving financial and investing advice my list is pretty dynamic, I constantly review and refine it. On rare occasion, when I run across something new and interesting, I add to it.

Odd’s 10 Basic Principles of Investing

• Start Right Now: When you have money to invest, put it to work. Don’t wait for the perfect moment or the perfect stock because they may never come.
• Diversify: A fancy way to say don’t put all your eggs in one basket. If you diversify properly across several asset types, industries and geographies, you can lower risk AND improve returns at the same time.
• Dollar-Cost Averaging: Invest a fixed amount of money on a regular basis. This helps you form the habit of investing, lowers your cost basis, and helps you avoid the buying-high and selling-low syndrome common to beginning investors.
• Manage Expenses: Don’t let transaction costs, mutual fund fees, taxes and investing advice expenses eat up your earnings. This is particularly important for people with smaller portfolios, these expenses can take a big chunk out of your returns.
• Compare to an Appropriate Benchmark: Regardless of your goals or strategy, you should always compare your performance to a benchmark. That’s the easiest way to determine how well you’re implementing your strategy and whether or not you’re improving as an investor. Watch the indexes that track the types of securities that you invest in, and if you can’t beat ‘em, join’ em by becoming an Index Investor.
• Be Diligent: During long bullish periods, many investors tend to get overconfident and complacent. They stop learning about investing, stop adjusting their strategy, begin ignoring risk management principles, and lose touch with the current market and economic conditions. Diligence is your vaccine.
• Investor Psychology, Don’t Follow the Herd: It seems that most investors are willing to follow each other up mountains and off cliffs simply because that’s what everyone else is doing. Control your psychological impulses. Follow your strategy, don’t follow the herd.
• Keep it Simple, Invest in What You Know: Warren Buffet pushes new investors to stick to simpler strategies that are easier to master and Peter Lynch encourages investors to learn a great deal about an investment before risking any money. These are two of the most successful investors of all time. I trust them, and you should too. This is great advice for those of us that don’t have the time to learn complicated methods of research and analysis or read financial reports as thick as a phone book.
• Don’t Throw Good Money After Bad: Many investors tend to ride losers down because they hate taking a loss and because they’re always sure it’s “about to turn around”. These same investors also frequently take a profit too quickly out of fear that a stock can’t go up any further. Don’t throw good money after bad, hold on to your winners as long as they still meet your “buy” criteria and sell your losers when they don’t.
• Choose One Strategy and Work Hard to Master It: When you combine strategies with different (often opposing) goals and selection criteria, you are virtually guaranteed to trail the market. Really, that bad? Yes, that bad. Over 80% of professional fund managers and investing advisors lag the S&P 500. You have to excel to beat the indexes and to excel you have to master your strategy.

Odd’s 10 Basic Principles of Personal Finance

• Live Beneath Your Means: Regardless of your income, you should always strive to spend considerably less than you make. Form good habits that will help reinforce this behavior like paying cash, sleeping on large purchases, and paying off your entire credit card balance every month.
• Make Your Money Work for You, Invest It: Money stuffed in the mattress or stashed in a low-yield savings account will just get moldy and die a slow horrible inflation death. Invest your money so that it can grow.
• Preserve Your Capital: This principle follows “Make Your Money Work for You, Invest It” for good reason. There’s a big difference between gamblers and investors, make sure you’re the latter. This is your nest egg, you will need it for retirement. You won’t get a mulligan if you lose a lot of money on a stupid gamble.
• Personal Finance is More Than Numbers: People tend to associate personal finance with numbers but many personal finance mistakes are emotional, not numerical. Do you have the discipline to save every month? Can you master your impulse purchase urges? Will you stick with your investing strategy through good markets and bad? These are emotional, not mathematical, barriers to building wealth. Work as hard on your financial and investing discipline as you work on understanding and implementing each principle.
• Save at least 15% of Your Gross Income: I bumped the old 10% rule of thumb up to 15%. Why? Planning for retirement falls squarely in the individual’s lap today, people don’t get near as much help as they used to. Pensions are nearly extinct and social security may begin to shrink in the near future. In addition, stock market volatility has been much higher than the historical norm ever since the tech boom of the 90’s, and the 15% gives you a much needed cushion.
• Own, Don’t Rent: For anyone planning to live somewhere for two or more years, there is no worse way to spend money than to throw it away on rent. Rent isn’t tax deductible and every day in an apartment is a day you could have been earning equity. If you’re a first time home buyer, there has never been a better opportunity to buy than right now. Don’t interpret this as encouragement to splurge, rule #1 is still important. Buy much less house than you can afford.
• Take Advantage of Free Money: There are a lot of free money opportunities out there, take advantage of them. One of the best is the 401k Match which ranges from $2,500 to $5,000 at many companies. This dollar for dollar savings match is a free and instant 100% return on your money. IRAs and Roth IRAs are also great opportunities, they provide free money in the form of tax breaks and tax free investing. Mail in rebates, going to the library for books and movies, the list is basically neverending. Please post your favorite free money idea in the comment section below so we can all take advantage.
• Avoid Debt: Carrying a lot of debt is a sure way to add stress to your life and delay retirement. Wouldn’t you rather enjoy your money then send it to banks and credit card companies each month? Can you even remember what you bought? And don’t even get me started on paying interest, you might as well just burn your money. Try to limit your borrowing to a house and a car when you’re younger and just a house when you’re older. If you’re already in debt and need to dig out, my favorite approach is the snowball method.
• Increase Your Ability to Earn: One of the easiest ways to speed your way to retirement is to increase your earning ability and this is easier than most people realize. You don’t necessarily have to go back to school to get another degree (although that is enormously helpful). A common and effective method of increasing earning potential is to take on new and unfamiliar projects at work. This can help you build new skill sets, take on additional responsibility and provide networking opportunities with senior managers and others that you wouldn’t ordinarily have the chance to interact with.
• Protect Your Family by Planning for the Future: Families used to live closer together and tended to be larger. The notion of a patriarch and matriarch were common and I wish it wasn’t a concept that seems to be fading into history. Take the initiative, be the patriarch or matriarch of your family by teaching the younger generations and planning for their future. There are plenty of wonderful and powerful tools to help you; wills, estates and trusts to ensure your money is passed on as you wish it to be, 529 plans for college savings, and life insurance to guarantee future income for your spouse if you should die to name a few.
  

This is part of a larger article called The Golden Rules…

Many Beginners have trouble deciding which stock market investing strategy to choose, oftentimes they are even confused about what strategy they are currently implementing. This happens because most people learn about investing from their friends, coworkers, family, and whatever investing related magazines, newspapers, and Internet sites they follow. What they wind up with is a hodgepodge of random information to base their investments on rather than any cohesive strategy. The greatest danger in this is that, while most strategies work quite well on their own if implemented properly, they are usually quite disastrous when investors try to combine them together.

If you are new to investing, odds are you’re implementing a blend of several strategies rather than focusing your time and effort on just one. Take my advice, choose one strategy and stick with it, don’t try several at once. Like I mentioned above, when you combine strategies with different (often opposing) goals and selection criteria, you are virtually guaranteed to trail the market. Really, that bad? Yes! Over 75% of professional fund managers and investing advisors lag the S&P 500 as it is. Trust me, you have to excel to beat the indices and to excel you have to master your strategy.

Another reason many investors implement multiple strategies is that they think it will somehow decrease risk or increase returns. This is a mistake. Don’t ever be fooled into thinking combining strategies will insulate you from losses or optimize gains, only proper diversification and asset allocation can do that. Study several strategies, then pick one. Are you an aggressive investor with a long way to go until retirement? Consider becoming a Growth Investor. Do you want a low maintenance portfolio that will guarantee you the market’s return? Consider becoming an Index Investor. Are you risk averse and hoping to buy companies that are undervalued so that your portfolio can grow while limiting downside potential? Consider becoming a Value Investor. These are just a few examples, there is a great strategy for every type of investor, you will never need to combine them.

Ready to take a good hard look at the most popular strategies? Below I’ve compiled all of the investing strategy review articles that I’ve written since I started Money-and-Investing.com. Each article will explain the major goals, investment selection methods, strengths, weaknesses, risks, and long-term outlook for 8 of today’s most popular strategies. Very likely, you will be excited about several strategies since great investors have used them to outperform their peers and the market for decades. That is exactly why I conclude each review with a look at the investor profile best suited to each strategy. Pay particular attention to this section. You will not be able to master a strategy if it is at odds with your personality, risk tolerance, or investing goals.

Here is a list of the strategies we’re going to review. Feel free to jump around to ones that you’re interested in or read the guide straight through.
- Value Investing: “I won’t buy unless the stock is selling for less than it’s worth.”
- Growth Investing: “I’m willing to take some risks for portfolio growth.”
- Income Investing: “This money has to last a long time, I’m playing it safe.”
- Mutual Fund Investing: “I want professional expertise guiding my portfolio.”
- Index Investing (Index Funds and ETFs): “I’ll let the market do the work for me.”
- Momentum Investing: “I want to own hot stocks until they cool off.”
- Market Timing: “Ride the Bull and hide from the Bear.”
- Day Trading & Technical Analysis: “I have no fear of risk, I will take big chances for big gains.”

Best of luck and please add your thoughts to this post, we’ll all benefit from your questions and insights.
~ Odd

Back to main article, The Golden Rules…

This is part of a larger article called The Golden Rules…

Hold on to your winners and sell your losers, don’t throw good money after bad. While this is actually a component of investor psychology, I thought it was important enough to include in my top 10 list of investing principles.

Sounds silly doesn’t it, why would any investor hold on to their losers and sell their winners? Oddly, this is what many people do, and not just beginners. Even seasoned investors will fall into this habit occasionally if they’re not diligent about sticking to their strategy.

Let’s first talk about holding on to losers, almost everyone has done this so it’s an easier concept to absorb. We often put a lot of hard work into selecting investments. By the time we finally hit the “Buy” button we are confident that we’ve made a wise and profitable choice. However, investing is a numbers game, we can’t be right every time and we will inevitably pick losers now and then.

When this happens, rather than realizing that we either missed something when we did our research or that something has fundamentally changed about the company or the market, many of us still stubbornly believe that we made a good investment. Because we worked so hard to identify a good stock, we find it hard to believe that we were wrong. Even if the price is dropping while our other investments are going up we hold onto it because we’re sure the loss is only a temporary correction and that the stock will head back up very soon.

This behavior is frequently referred to as “falling in love” with a stock. We can’t bear to part with a “good” stock and taking losses is psychologically painful so we wind up riding our losers down. This rarely ends well. Eventually we realize that no recovery is in sight and we sell the stock back into the market at a much larger loss than we should have taken.

On the other side of the equation, when we review our portfolio and see that an investment has done particularly well, we are often tempted to take a profit because we don’t think that any company can sustain such exceptional performance for long. Stock investors are more likely to behave this way than fund investors since they are looking at individual stocks but it can happen to anyone.

Let’s use Google for an example again. The company’s IPO occurred in August 2004 and many of the early investors bought in for between $90 and $110. By April of the following year the stock was already trading at about $180 but the stock price had been flat for several months and appeared to have hit resistance. As a result, there was an enormous amount of selling volume in April. Had Google’s growth potential or business environment changed? No, the selling was simply early profit-taking by skittish investors. Four months later on the one-year anniversary the stock was trading at $300. By the third anniversary in 2007, the stock was trading for $510. Ouch, painful lesson.

Let’s recap Principle #9…
As painful as it is to take a loss, smart investors set sell limits for every investment that they buy. If it gets close to that limit, they reevaluate to see if they erred in their research or if something has fundamentally changed. Regardless of the situation, if the investment hits the sell limit, they get rid of it, they don’t ever hold on hoping it will go up because they know their money will be better off working for them elsewhere.

On the other side of the equation, avoid selling winners by doing as much homework before you sell as you did before you bought. If the company still meets all of the criteria for your strategy, isn’t it still a winner and shouldn’t you hold onto it? Trust your strategy and hold onto any investment that still meets all of your buy criteria, there is no limit to how high a stock can go so price appreciation should get you excited, not scare you to the sidelines.

Don’t throw good money after bad. If you hold onto losers or sell winners, you are not managing your money efficiently and this will kill your returns. The easiest way to correct this behavior is to stay objective with every investing decision and stick to your strategy, never let your emotions make investing decisions for you.

Best of luck and please add your thoughts to this post, we’ll all benefit from your questions and insights.
~ Odd

Back to main article, The Golden Rules…

This is part of a larger article called The Golden Rules…

This principle actually covers two important concepts that became popular thanks to a pair of today’s greatest investing minds, Peter Lynch and Warren Buffett.

“Invest in what you know” – Peter Lynch
Remember Peter Lynch from the Mutual Fund Basics Guide? The guy who took over the $18Million dollar Magellan Fund in 1977 that grew to more than $14Billion in assets by the time he retired only thirteen years later in 1990. Peter advises beginners to “invest in what you know”, and his message still resonates with working people who don’t have the time to learn complicated technical analysis or read financial reports as thick as a phone book.

Invest in what you know. Sounds simple but there is a lot of wisdom in this advice. Lynch meant that in our everyday lives we tend to become experts in some field or another either because it relates to our career or because we use related products on a daily basis. For example, if you’ve been a pharmaceutical salesman for the past 15 years, you probably have picked up a lot of knowledge about the major companies, the industry, how a product is tested and marketed, not to mention detailed knowledge on any drugs that you have sold during your career. This expertise is your foundation and gold mine as an investor.

To emphasize this point, imagine the following example in which you are the pharmaceutical rep described above and you are trying to decide between two different investments.

The first is a profitable and established pharmaceutical company that you’ve been competing against for 15 years. Your friends think it’s a boring stock and point out that their share price hasn’t budged in five years while the market has made great gains. They tell you that new drugs come out all the time, and remind you that this company has already released two this year without making any impression on investors or impact to the share price.

However, you know that this pharmaceutical company has solid patents and recently received FDA approval for a cheaper generic version of a very expensive drug that your company makes. Sales for your company’s competing drug have plummeted as a result. You also know that this is a popular drug, many doctors will prescribe it to the elderly on a regular basis. You ask around different companies and reps in your industry and find that no one else has anything in testing or pending approval that can compete on a cost basis. Finally, this company is huge, they will have no trouble digging into their deep pockets to market and mass produce.

The second potential investment is a tech IPO that your broker and a couple of your friends are really excited about. Apparently they invented some type of technology that can improve the speed of all search engines and they just landed Google as a client, the major player in the search engine space. As a result of the Google deal, they are already making money which isn’t always the case for many startup tech companies. You’re seeing a lot of news about this IPO, it looks like it will be a hot stock since there’s already so much buzz. Your broker even offered to get you some IPO shares which will probably net you a nice profit on the very first day of trading.

What would Peter Lynch do? He would buy the pharmaceutical company every single time. Here’s what you know. The well-established pharmaceutical company has a new patent protected drug that is already approved for sale by the FDA. The tech company has an unproven product, investors don’t even know if major search engines such as their new client, Google, will need or continue to use the technology. The drug is already proving itself by outselling you, the competition. You have no idea how well the tech company is equipped to compete and it sounds like they may be dependent on their one major client for survival, Google. Not a strong position. Finally, there won’t be any competitors for several years for the drug company because no one is even testing a competing product yet. What are the barriers to entry for the tech company, could one pop up tomorrow or could Google or Yahoo just make their own version of the technology?

I don’t want you to get the impression that you should avoid every strategy, stock, or fund that you don’t know much about. What I’m trying to say is that you should play to your strengths when you invest. Invest in what you know when you can and when you want to try something new, take the time to learn a lot about it first.

Ignoring this rule can ruin even great strategies. For example, a value investor is always looking for great bargains, i.e. underpriced stocks. But if they buy companies that they know little about, more often than not they’ll wind up with a stock that has done something to deserve a low share price and would have been best avoided. There is an enormous amount of information available for any stock or fund that you’d like to buy. Study the company, their competition, their products, the industry, their historical performance, their earnings, the fund manager and anything else you can think of before you decide. This sounds like a lot of work but your portfolio will reward you generously in the form of profits if you do your homework.

“Keep it simple” - Warren Buffett
When Buffett tells individual investors to keep it simple he is most often encouraging them to become Index Investors. But isn’t he a Value Investor? Yes, but he is a value investor with an almost super-human knack for numbers, 30+ years experience, a lifelong passion for learning about investing, and he spends the majority of his waking hours studying the companies that he buys. I certainly don’t expect to ever develop that level of expertise and definitely don’t want to spend that much time studying my strategy. So, for an average joe like me, he’s actually giving wonderful advice.

Buffett is comfortable giving this advice because he knows that, if you want to encourage investors to keep it simple, Index Investing is a great strategy to recommend. It’s easier to learn and lower maintenance than most, so new investors can master and maintain the strategy much more quickly than more demanding strategies such as Value Investing or Growth Investing. Index Investing is also the most cost- and tax-efficient strategy you’ll find since you buy-and-hold-and-hold-and-hold. Most important, this strategy allows the average investor to compete with anyone, Index Investors beat over 75% of all professional fund managers and analysts.

Sorry about the tangent, I get excited whenever I get the opportunity to talk about Index Investing, it’s a great strategy for any investor (not just beginners). If you’d like to learn more about Index Investing, Index Funds or ETFs, I’ve written a couple of related posts. Read this Index Investing Strategy Review if you want a brief introduction or, if you’re feeling really ambitious, read my Complete Guide to Index Investing.

Back to the point, Keep it simple… this is so true about everything in life and it’s especially true about investing. As a beginner, you are probably overwhelmed by the amount of information you need to learn to become a savvy investor. This is a good time to point out an important fact. Your confusion is a result of your lack of knowledge and from the overwhelming amount of new information I’m throwing at you, NOT because investing is complex and sophisticated.

Don’t stray from the keep it simple philosophy as you become a more seasoned investor. Einstein said that “everything should be made as simple as possible, but no simpler” and that’s great advice. You have to understand the basics of your strategy, but don’t needlessly add complexity because you feel being a more sophisticated investor will make you more successful.

Best of luck and please add your thoughts to this post, we’ll all benefit from your questions and insights.
~ Odd

Back to main article, The Golden Rules…

This is part of a larger article called The Golden Rules…

I define Investor Psychology as the herd mentality that is so obvious when you watch short-term stock market behavior. It seems that most investors are willing to follow each other up mountains and off cliffs simply because that’s what everyone else is doing. There are tons of outstanding examples to illustrate this lemming-like behavior, but we’ll go with a a Google example since it’s a company almost everyone has heard of.

3/17/2008
Bear Stearns, a major investment brokerage, made some very bad bets on sub prime mortgages and was on the brink of bankruptcy. JP Morgan Chase and the Federal Reserve Bank announce a deal to buy out the troubled brokerage on 3/17. JP Morgan winds up paying an unbelievable $10 per share for a stock that had traded for $100+ per share as recently as three months ago.

Some professional analysts and news pundits begin clamoring that we can “expect to see multibillion dollar companies falling like dominoes in the weeks and months ahead.” They pronounce that we “may be going beyond recession and into a depression” and that “the inevitable crash we’re experiencing is a result of the worst liquidity and banking meltdown this country has ever seen.” Many investors panic and immediately flee the market thinking cash, treasuries, and bonds are the safer bet until they can figure out what the market is going to do.

As a result, Google’s stock price plummets by 4.12%. $5.7 Billion in Google shareholder value (market capitalization) is lost in a single day. Wait a minute… Google is a global company, not just a US company and they’re not even in the financial sector, right? Right. And Google continues to post strong earnings, great growth and is dominating their competitors in market share and revenue growth, right? Right. Google still has the same solid management in place and isn’t in any sort of financial, litigation, or other major trouble either, right? Right. So what the #^% happened? In short, investor psychology. When people panic you see a lot of short term fluctuation in share prices as a result of their behavior.

3/18/2008… One day later:
The Federal Reserve Bank holds its monthly meeting and slashes interest rates by 75 basis points. They calm fears by reminding people that inflation is in check, promise to keep pumping cash in to ease the liquidity crunch, and demonstrate again that they are willing to do whatever is necessary to stabilize the economy and avoid a prolonged recession.

Professional analysts and news pundits are clamoring again but this time they tell us that the Fed is making some brilliant moves. “They have revived measures not used since the great depression, pumped over $200Billion dollars into the system to ease liquidity, and gone on the most aggressive rate cutting spree we’ve seen since the early 1980s banking crisis.” They assure us that the Fed has done so much that we are going to see strong price action in the coming weeks and months and are likely to avoid a recession. The same investors that panicked yesterday panic again, but this time they are flooding back into the market for fear of missing out on a big rally (which they ironically create).

Only one day later, Google’s stock price soars by 4.59%. $6 Billion in Google shareholder value is created in a single day. Do you think Google’s true value really changed so drastically in a two day period? Of course not. There is simply a lot of volatility in the short term, which is why you need to understand a little about investor psychology, so you can avoid the herd.

In the example, the herd sold on the way down and bought on the way up. If you buy high and sell low you are guaranteed to lose money. Unfortunately we are programmed to act this way, your mind will try to get you to make stupid stock market moves whenever you are scared or stressed, you’ll have to make a conscious effort to avoid these mistakes. Warren Buffet once said “simply attempt to be fearful when others are greedy and to be greedy when others are fearful” and I think that’s brilliant advice.

To avoid all of this unnecessary stress, master your own psychological impulses. Hold on to your winners for as long as you can, at least a year, and don’t let short-term market volatility scare you into or out of the market. Why? Long term investors win, short term investors lose, and that’s not a theory, it’s a fact. Also, avoid bouncing between strategies when the market changes, reacting to news, or trying to time the market by moving back and forth from cash to stocks. If you understand your strategy and are good at implementing it, you should wind up with high quality stocks that you bought at a good price and that you can hold onto for a long period of time.

Best of luck and please add your thoughts to this post, we’ll all benefit from your questions and insights.
~ Odd

Back to main article, The Golden Rules…

This is part of a larger article called The Golden Rules…

During long bullish periods, many investors quit learning, stop adjusting their investment strategy, and lose touch with the current market and economic conditions. Eventually, every portfolio will need adjustments. For example, a value investor may hold a stock that has become a growth stock or whose fundamentals have drastically changed, an Index Investor may not have noticed that an ETF has a much higher expense ratio or a momentum investor may no longer be paying attention to risk management when the next market correction occurs. These are painful lessons to learn and unfortunately most people have to learn from it (or fail to learn from it) over and over again. Diligence is your vaccine.

Why does this happen? Human nature. When you find a strategy that works over a long period of time ranging from a few months to several years, depending on the investor, you tend to gain a lot of confidence in your investing ability. While confidence is an important trait for an investor, it tends to settle you into a comfort zone. Many people have asked, “are you just saying that people shouldn’t get over-confident?” No. My point relates more to getting confident enough to slip into a comfort zone than a distinction between confidence and over-confidence. We are all guilty of this, it’s a normal reaction.

The first side effect is that you will stop searching out new investing information to add to or challenge your own knowledge. When you believe you already know enough to invest well, it’s hard to find the motivation to continue seeking out new information. This leads to the second side effect. When you aren’t pursuing new knowledge, you can no longer improve, refine or adapt your investing strategy.

If you have stopped seeking knowledge and no longer adjust your strategy BUT your investments STILL do well, you will inevitably experience the third side effect. Since things are going so well with so little effort, you will begin losing touch with and interest in changing market and economic conditions. At this point you are in a complete investing vacuum, you are completely out of touch with your portfolio and with current market conditions.

No one, not even an index investor, can get away with this mistake unscathed. When you do realize your mistake, you’ll have to catch back up on everything and, as every beginner learns quickly, learning curves can be steep and painful for those that fall behind. Whether it’s reallocating to balance your portfolio or switching industries to continue finding value stocks, most strategies (good ones at least) will require some adjustments when the market and economic environments change. Because you didn’t make these adjustments when you should have, not only do you have a learning curve to climb but you’ve already experienced losses that you could have avoided.

So how do you avoid this? The most successful approach I know of is to discuss a wide variety of investing topics frequently. Don’t worry if you’re a beginner and don’t know many investors yet. Finding people to talk to is as easy as a Google search, you’ll be shocked by how many options are readily available. Want to check for yourself? Try searching for investing forums, investing discussion boards, or check any of the major investing sites for discussion areas. Prefer face-to-face interaction? Search your local area for investing clubs, free investing and personal finance seminars (meet other investors), or just talk to your friends, many of them may appreciate sharing the new knowledge you’ve picked up and will try to return the favor.

Here at my blog and at other similar sites, you’re learning a lot about investing, but when you interact with others on a more personal level you get to hear real life experiences. Absorbing the wisdom and knowledge of experienced and successful investors is a great way to learn, you can’t beat on-the-job-training. When you are a more experienced investor, it’s also fun and fulfilling to teach others and this reinforces your own knowledge. Interacting with others provides a fresh perspective, pushes you to continue learning, and sometimes even provides new insights that you can incorporate into your own investing strategy.

Best of luck and please add your thoughts to this post, we’ll all benefit from your questions and insights.
~ Odd

Back to main article, The Golden Rules…

This is part of a larger article called The Golden Rules…

One of the most common and costly mistakes that new investors make is not measuring their performance against an appropriate benchmark. Many don’t compare to ANY benchmark, much less an appropriate one. What is the danger? The biggest drawback is you will never really know how well or poorly you are investing.

A stock-tracking index such as the S&P 500 is the most common type of benchmark. There are tons of them, they are easy to look up, and there are plenty of free tools available that will allow you to compare your performance to an index with just a couple of mouse clicks. I’ll provide a list of the most popular and which strategy they match in the chart below.

Here’s an example to put this concept into context:

The year is 2003 and all of your money is invested in Large Cap US companies. Your total portfolio increases by 14% for the year. Pretty strong, right? The problem is that you have absolutely no basis of comparison. Now let’s add some information and see how drastically it can change the picture.

The S&P 500 Index contains 500 large cap companies, so it is the perfect benchmark to use for this example. In this example, you gained 14% for the year but the actual S&P return for 2003 was more than double at 28.68%. To add insult to injury, let’s also throw in the possibility that your returns are much less because you selected highly volatile companies and a few tanked. This means that not only did you trail the S&P returns dramatically, but you are also likely to lose money faster than the S&P 500 when the market turns bearish since you have a higher risk portfolio.

Regardless of your strategy or goals, you should always compare your month-over-month and annual performance to an appropriate benchmark. I already mentioned that if you don’t compare you’ll never know if you’re improving as an investor. Another major reason is to see how well you are implementing your investing strategy.

For example, if you’ve chosen to purchase large growth stocks and technology stocks a good index to compare too would be the NASDAQ 100. If you outperform the index for several years in a row, then you have proven that you are good at implementing your strategy of buying high potential growth and technology stocks. However, if you are underperforming the index, you either need to study your strategy more or just buy an Index Fund or ETF that tracks the NASDAQ 100.

Unfortunately, many people think that buying an index fund is like throwing in the towel. They feel this way because it means accepting the market returns, index investors aren’t really implementing any traditional investment strategy. However, here’s a little secret to keep in mind; index investors beat over 75% of investing professionals and an even higher percentage of individual investors. If you want to learn more about Index Investing, read this Complete Guide to Index Investing or my Index Investing Review (Index Funds & ETFs). If you can’t beat ‘em, join ‘em.

Most beginning investors feel intimidated when they hear index names like the S&P 500, Dow Jones, or Nikkei so here’s an alphabetically index list to help you figure out which index to use. A common question is “what if I have several types of investments?”. No problem. That means you’ll look at more than one index and you should compare each investment or group of investments to their relevant index.