Portfolio Don'ts

Warren Buffet's 60-year investing partner, Charlie Munger— who died late last year one month shy of his 100th birthday—  famously said about the astonishing success of Berkshire Hathaway since the early 1960s: 

"It's not brilliance. It's just avoiding stupidity."  

But what comprises stupidity? Is it one-time foolishness or a pattern of dumb? A reckless mistake? A poorly devised strategy? Can someone of average intelligence achieve truly impressive investment returns? (I did.)

The reality is the list of don’ts in investing is probably longer than the list of do’s. But they're pretty much all quite intuitive. Which means they’re more accessible to regular folks who have never studied finance or who have crazy schedules and simply can’t put in the time to nail the details. Which is to say, if you can just avoid touching the third rail, you’ll probably do fine. 

 

Don’t invest in mutual funds.

I have previously expounded on this subject but I’ll nutshell it here: if you feel you aren’t ready to pick your own stocks, get yourself an online brokerage account at Morgan Stanley/E*Trade or Schwab/TD Ameritrade and pick up a couple of exchange traded funds (ETFs), which hold a basket of companies but trade as a single stock. The easiest are the large-basket ETFs like SPY and VOO which mimic the movement of the largest market index of 500 different stocks. 

 

If instead you insist on buying into a mutual fund, you’ll pay 1.25% of your assets per year for that fund manager’s ‘expertise.’ 1: something like 90% of those managers do not even keep up with the growth of the S&P 500 index, which you can have for a fraction of the cost (see SPY, above); 2: that cost becomes absolutely massive over time as your portfolio grows and that rate compounds; 3: your money will be much less liquid should you need to access it. It's like paying someone for the privilege of being robbed— you lose twice. Don’t believe me? Read this. 

 

Don’t worry about the price of a share unless you’re spreading your investment around.

Lots of people get weirded out by the cost per share. They think that if they only have $100 to invest in a particular stock and one share is $100, better to find a different business for $20 per share and buy 5 shares. Which is ridiculous: if you’re going to put to work the same dollar amount, then 10% of share appreciation is 10% wealthier either way. Go with the company which best fits your investment model and your interests. Where share price matters is if you want to spend your limited investment budget on several businesses or ETFs to diversify. 

 

The other thing that happens is that people avoid companies analysts describe as “overvalued,” whose shares have risen substantially over recent months or which are pushing higher PE ratios. The thinking is that if it’s gone up that much it’s probably close to tapped out, and the price will flatten or even fall. But no matter what analysts say, that stock’s price has risen because investors overall have decided it’s worth a lot more than previously thought. Perhaps the company acquired a competitor, or announced an international expansion, justifying the rise. If instead you only buy stocks “on a dip” or that you think are cheap, you miss out on some amazing opportunities (think Apple, Microsoft, Netflix, Nvidia—no one accuses their stocks of being bargains). Companies with rising valuations tend to keep rising until something changes: a new competitor, a corporate scandal, an economic shock. If you stop worrying about how high the price looks today, and measure it instead against what you believe to be its growth potential tomorrow, you’ll have a much clearer understanding of the real value. That's why you want to own it in the first place.

 

Don’t buy blind.

When we hear from a gym pal or the deli guy about a great value stock, a sudden opportunity that "won’t last long," our inclination is to believe they know something we don’t and therefore we should hop to it. But it ought to be a red flag: if you’re hearing about it from someone else, then you’re not following that business or you would already know this information. Which means you're buying something you likely know nothing about. Plus, if word has gotten around, then any amazing value price is likely already over. Don’t succumb to the temptation to go in with your friend just because. Learn about that business. Do a little research. Understand what the company does, how they stack up against competitors, what sort of leadership they have, how their growth trajectory looks. Get a feel for things. If you don’t understand how the company makes money today, then you can't see how big the opportunity is in the future and you can't possibly assess it as an investment. Never forget: you’re buying an ownership stake in an ongoing business. Where is it headed? How will it achieve that? What obstacles will it face? Look before you leap.

 

Don’t be in a hurry. 

Unlike in the movies, investing is not shorting orange juice futures one time and then finding yourself living on a yacht in the Bahamas. Investing is a lifelong process. It requires an understanding that the value of your assets will rise and fall in in the near term but, with dedication and patience, will almost certainly increase substantially over time. 

 

Many people succumb to action bias, which is just the need to do something with your investment portfolio beyond just watching it grow. Because most folks don’t have an endless supply of incoming cash with which to buy more or different stocks, they instead move the money they have from one investment to another, looking for higher or faster returns. But that eliminates any one company's ability to earn them a substantial return over time, it kills the stunning advantage brought by compounding interest, it generates capital gains taxes, it takes time and energy and increases frustration. Instead, buy smart and sit tight: investing, not trading. Your returns will demonstrate the difference. 

 

Don’t sell on movement.

Everyone sets out to buy low and sell high. But the reality is often very different: we buy high and sell when it drops because we fear it will keep dropping. For obvious reasons, this is a terrible  investing strategy.

 

Once you own shares, don’t sell unless you must. I go into greater detail in previous posts here and here, but the basic idea is that if you did at least a little due diligence prior to purchase, and you still like the company and believe in their capacity to grow, then you shouldn’t sell just because it has moved up or down. Stocks swing, sometimes a lot, and sometimes very quickly ("Escalator up, elevator down."). When a stock you own drops substantially following a missed quarterly earnings report, that is a Wall Street analyst’s problem, not the company’s or the shareholder’s problem. If you still believe in the company, its shares are now on sale! If the shares rise, maybe even more than you expected, Wonderful, you've made more than you thought! You bought it to hold it, expecting it would go up— now let it do that. The money is supposed to work for you, not the other way round. Sell only when something really bad has happened at the company or when you need the money for something else. Trust your purchase, trust your judgment. Patience is rewarded.

 

Don’t let your emotions take over.

Investing well, and I’ve said this before here, requires a steady hand on the wheel and your eyes on the horizon. There’s just no way around it. Stocks rise in the long term, but they gyrate all over the place in the shorter term. Some of it is nauseating. This is especially true of young companies, technology companies, and of fad companies, whose products or services might turn out to be just a momentary cultural obsession and will fall as fast as they rose—think GoPro cameras, 3D printers, Zoom video-conferencing, Peloton bikes. If you act on your emotions, you might save yourself a headache or a sleepless night but over time you will have terrible returns. Never buy on a whim of fancy, and never sell in a panic. Buy with some vision, some thought and analysis, and then then sit on your assets for years if you can. That’s it. Containing yourself is extremely hard, but it’s certainly not complicated.

 

Don’t wait.

You’ve been hearing it since you landed your first job, if not earlier: the longer you put off the start of your investing career, the less time you’ll have to earn enough to stop working. You see the huge hockey-stick shape to the right? His net worth grows steadily enough over time but really accelerates in the last decade or so: That’s compounding interest. I keep saying it: the longer you do it, the faster you’ll earn and the more you’ll have. Investing is the slow boat, so get on now. For more about waiting to get started, have a look at this.