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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

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.

You probably noticed that there is a lot of overlap. You don’t have to choose the perfect index, you can either select the most popular or select several, just make sure you choose indexes that are relevant. Say you’re buying Blue Chip stocks, you should definitely look at the Dow Jones Industrial Average but you may also want to occasionally compare against the S&P 500 since it is a similar large cap indexes.

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

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Investing expenses can quickly eat into your earnings, especially if your portfolio is still relatively small. There are many types of expenses but the most dangerous to your portfolio are transaction costs, taxes, and investing information costs.

Transaction costs come in many forms but they all chip away at your returns, especially if your average transaction is small. This is how regular and online brokerages make money, they charge you when you buy and sell stocks, bonds or mutual funds.

These fees vary greatly, but one important piece of information I can share with confidence is that it is much more expensive doing business with a local financial planner or broker. They usually charge $35 or more per trade regardless of what type of investment you buy. In addition, planners will charge you for various services or by the hour, depending on the planner, and that can run into the thousands. They also tend to push the funds that pay them the biggest commissions. Beware the planner that ever pushes a fund loaded with fees and expenses, there’s no reason to pay them now that you can trade them online for free (see this Mutual Funds Basics guide to learn more about No-Load Funds).

In contrast, the typical online trade is around $9.99 for stocks and most funds trade for free. Brick and mortar brokers and planners justify their much higher transaction fees by saying you are paying for their expertise, not just the transaction. Not many earn that extra money. Great investment advice is pretty cheap nowadays, some of the best investors in the world provide investment advisory services that cost less than $200 per year. There are always exceptions, so if your local planner is great, keeps fees low and outperforms the market, by all means, stick with him. While $9.99 online trades are much cheaper, they can still add up. Take my advice and keep track of all your fees, avoid local brokers and planners, and buy and hold as long as possible unless you’ve picked up a real dog.

Taxes are another large expense for those of us with portfolios in a taxable account. My first piece of advice is to stick every penny you can into tax deferred accounts (read our 401K, IRA and Roth IRA Basics guide to learn more about tax deferred accounts). This will allow your money to grow tax-free until you retire which will save you a fortune in tax expenses. If you can’t put all of your savings into tax deferred accounts, the best way to keep your tax expense low is to hold your investments for as long as possible. Why? If you hold an investment for at least one year before you sell, you only have to pay the long term capital gains tax on the profit which is 15% for most of us and 5% in the lowest tax brackets. If you don’t hold your investment for at least a year, you will pay your normal tax rate which can be as high as 35%. Long story short, buy and hold.

My last category, investing advice expenses, consists of the price you pay for whatever type of investing advice you buy each year. It can consist of financial planning, web site subscriptions, monthly investing newsletters, investing classes, and magazines subscriptions to name a few. I can’t imagine how you would ever need to spend more than $1,000 per year to get great information. Spend even less if you are a beginner and your portfolio is still small because these expenses cut into a much larger % of your profit.

Of all the different types of investing costs, investing advice expenses are the easiest to manage if you do a little research before you buy. Here are a few tips to help you save money but still get the best investing advice available.

Keep up with the market and the economy:

• A 12 month subscription to Smart Money published by the Wall Street Journal only costs $14.99 per year. This magazine contains outstanding content similar to the journal with a little more emphasis on personal finance articles than the Journal.
• Kiplinger’s Personal Finance costs $19.99 per year. Despite the title, this magazine focuses on both the market and personal finance. Great content plus a lot of educational material.
• Money Magazine $14.99 per year. This magazine contains a little something for everyone, you can always count on each issue to emphasize a different aspect of personal finance and investing. Like this site, they shun the ivory tower mentality. Their publication is a fun and easy read and it always provide a lot of high quality educational content.
• A weekly subscription to the Wall Street Journal is $99 per year. Heavy emphasis on everything market-related. They can tend to focus on what’s hot but the Journal contains a lot of solid and timely analysis.

Investing Advisory services that provide specific buy/sell recommendations and model portfolios:

• Equity Fund Outlook for Mutual Funds $149 per year. Edited by renowned fund expert Thurman Smith. Emphasis split between tax deferred and taxable accounts. Provides strategy, model portfolio and specific buy/sell recommendations.
• Fund Street© and ETF World Investor© for Mutual Funds and Index Investors $149 per year. Proven market beater that provides a lot of market analysis and investment/personal finance tools. Emphasis on long-term growth and Index/ETF funds. Provides strategy, model portfolio and specific buy/sell recommendations.
• The Prudent Speculator for Stocks $195 per year. Market beater for over 25 years. This seasoned investing team is led by Al Frank’s protégé and successor, John Buckingham. Emphasis on growth stocks. Provides strategy, model portfolio and specific buy/sell recommendations.

Financial Planners:

• If you feel you need a planner to get started, consider trying an hourly planner out rather than the more traditional fee-based planner. They claim you pay a premium for expertise so that’s all you should use them for. Don’t go through them to buy or sell stocks or funds, just get their advice at a reasonable hourly rate and don’t go back if you don’t feel you got your money’s worth. Generally they are worth the dollars spent if you need help with advanced estate planning, insurance planning, or tax planning.

Investing Education Classes:

• Typical investment workshops, seminars and courses cost anywhere from $1,000 to $5,000 and I’ve yet to see any material that you couldn’t have gotten on line for free or at your local bookstore for $20. While I don’t think you’ll find a better resource than Money-and-Investing.com, there are many other similar sites that offer high quality free information on related topics. Why pay thousands when there’s so much great free (internet) and inexpensive (bookstore) investing information available?

Data, charting, and investing analysis web site subscriptions:

• Hopefully you’d prefer to at least validate the recommendations you’re getting from your advisory services. Since all investing research sites are different and can be tough for the newbie, I’m only going to recommend my favorite and most user-friendly, Morningstar.com. They have a great variety of free investing tools, so check out the free stuff before you sign up for the paid service. Even if you decide to buy, the subscription is only $14.99 per month and it includes exceptional tools for screening, researching, and selecting stocks and mutual funds. If you want to learn more, read Morningstar.com, the Power of Institutional Investors at your Fingertips guide.
• I highly recommend the approach above (i.e. learning to validate your advisory service’s stock and fund selections), but… if you don’t plan on doing much of your own research and analysis, don’t join a pay site. In-depth research and analysis services are wasted on the casual investor that simply buys the stocks, bonds and funds that his advisory service recommends. This type of investor will generally only need to look up quotes, charts, financial results, news and other basic information. If this is you, invest your money at any of the major online brokerages, they will have all the tools the casual investor will ever need.

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

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Dollar Cost Averaging means investing a fixed amount of money on a regular basis. For example, if you invest $300 every month regardless of market conditions, you are dollar-cost averaging. The benefit is that you wind up buying more stock and reducing your cost basis. Huh? Yeah, it’s a little confusing. Over time, the market trend is usually up, the S&P 500 average annual return since 1975 has been 10.75%. If you invest a fixed amount every month, especially during bear markets and corrections, you are buying stock at lower prices which allows you to buy more shares. When you combine a positive trend with buying low, you get more stock at a lower cost basis.

The reason this behavior made my list of top 10 investing principles is because most investors do the exact opposite. Don’t you feel the urge to buy when the market is bullish and rising and feel the urge to wait or sell when the market is bearish and dropping? Most people do, and as a result they buy when prices are high and do nothing or sell when prices are low or falling. This kind of behavior greatly increases your cost basis and decreases your returns, so avoid it, be a dollar-cost averager.

This is easier to understand with an example:

• Dollar-Cost Averaging: Let’s say you decide to buy $300 worth of an S&P 500 index fund per month for three months regardless of market conditions. In the first month the price is $12 so you receive 25 shares, in the second month the price is $15 so you receive 20 shares, and in the third month the price is down to $10 so you receive 30 shares. Your average cost per share is $12 ($900 invested / 75 shares owned), you bought the most at a lower price. When the index goes back to $15, you have your $900 investment plus a $225 profit for a total of $1,125.
  
  
• Typical Investor Behavior: Now we’ll look at how most investors behave. You loved the index fund at $12 so you bought the same 25 shares as the dollar-cost averager, and you loved it even more at a bullish $15 so you bought the additional 20 shares. Unfortunately, when it dropped to $10, you got nervous and decided it would be best to wait and see what happens before you sink any more money into the market. Your average cost per share is $13.33 ($600 invested / 45 shares). When the index goes back to $15, you have your $900 investment plus a $75 profit for a total of $975.

The dollar-cost average earned a 25% return while the other investor only earned 8%. Remember that even if the market plunges it always recovers for long term investors, and when it is low you will snatch up a lot of shares at bargain prices. As long as you are dollar-cost averaging you will always be buying shares at a cheaper price.

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

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

Diversification is a fancy way to say “don’t put all your eggs in one basket”. If you own the right number of stocks, bonds and funds and they are allocated across several categories, industries and geographies, you can substantially lower the risk of losses to your portfolio and increase returns at the same time. What?! That’s right, if you diversify properly, you lower risk AND improve returns at the same time, making this a no-brainer. How does it work? Diversification is the process of finding the investing sweet spot where you optimize the risk Vs return of your portfolio.

Uh oh, “optimization”… sounds like you’re about to be bombarded by statistics doesn’t it? It sounds complicated but it’s not. There are only three things you need to focus on as you create your portfolio to make sure you’re creating diversity; the number of securities, the mix and the asset allocation.

I’ve always felt that owning between 25 and 30 securities is the optimal number but this can vary based on strategy and risk tolerance. Less than 25 and you haven’t truly diversified, your losers can still really hurt your overall returns. More and you get diminishing returns from too much diversification, you might as well buy an index fund and let it ride if you’re going to carry 50 or more stocks. 25 to 30 securities is a lot, and many beginners don’t have that kind of cash when they start investing. Don’t worry, mutual funds were made for you, many of the best ones will give you full diversification with an investment as small as $500. Click on the following links if you want to learn more about Index Funds or Mutual Funds before you finish this article.

The second critical piece is the diversification mix. You want to invest in a wide variety of industries, categories and geographies to ensure that when one specific area goes south, it doesn’t tank your whole portfolio. For example, if you own a telecom and suddenly the industry is getting bad press due to invasion of privacy lawsuits, the rest of your portfolio can cover the losses of that stock. Why? If you’re diversified, that’s probably your only telecom, the rest are in unrelated industries and won’t be directly affected by these lawsuits. Also, your portfolio should be spread across a wide variety of categories and geographies, most of which won’t correlate with anything going on in telecom, some may even be inversely correlated (meaning they do well when telecoms do poorly).

Finally, make sure you have a diverse asset allocation. This means spread your money between various types of investments. Don’t buy only stocks, bonds or funds, buy a combination. The reason you want a blend is because each type of investment behaves very differently. Stocks, for example, have the highest potential return of any type of investment but they also have the highest risk of losses. Bonds, on the other hand, can’t provide the types of returns a stock can but they offer stability since their returns are often guaranteed. A blend of different asset classes is just another way to diversify and you can choose from a wide variety of allocations. Here is a good rule of thumb. The further you are from retirement the more you should allocate to more aggressive investments like stocks, and the closer you are to retirement the more you should allocate to shorter term lower risk investments like bonds

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

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