Recently, I heard an exasperated parent talking to a teenager who was testing him. I thought the parent's response was classic. "I know you know the answers to all the questions you're asking, but I'm not sure that you realize you don't even know the right questions to ask yet!" In the markets, what you don't know WILL hurt you! This article is not a detailed course, but merely trying to point potential new stock investors in the right direction to find the questions they need to ask before putting their money in jeopardy!
The immortal P.T. Barnum is supposed to have said, "There's a sucker born every minute". The statement refers to people who believe they have special abilities or know more than others. The world is littered with average people who used to believe that it's easy to beat the market!
The good news? It is possible! Warren Buffett and Charlie Munger proved it! Other fund managers continue the tradition of investing wisely, and therefore provide excellent results over the long-term. The downside? It's work - and lots of it - to find real opportunity in the markets and to stay ahead, or at least on a par, with other investors. You'll also need access to timely data. That's an expense that most investors ignore as they launch their careers as market beaters!
Ben's Rules
Ben Graham developed the basics of portfolio theory. His students included Warren Buffett and many other legends of Wall Street. His first book (Security Analysis) claimed "An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative." His second book, The Intelligent Investor (1949), has been described by Buffett as "the best book about investing ever written". These two books are still required reading if you want to work at several investment management firms!
We don't intend to review the entire
Intelligent Investor book, but will provide a bit of background to encourage potential self-managed investors to read more!
Rule #1 in Ben's eyes was "Don't lose money". Buying stock which is worth more than the current price of that stock provides a base to prevent serious losses. Identifying these opportunities requires detailed study of the financial documents produced by the company. The intelligent investor must know how to read financial statements, and must know the industry in which the company operates to be able to interpret them accurately.
The investor should understand the competitive position of the company. There should be a "moat" around the company's products to prevent the competition from copying them and driving down the profits of the company. Examples of a moat would include patents, brands, manufacturing capabilities, management experience, and so on. Again, significant knowledge of the company and the industry is essential for investor success!
Other Approaches?
The portfolio management approach demands both work doing fundamental analysis and patience to let the market appreciate the value of the stocks in your portfolio! The opposite of this patient approach is day trading, where the investor watches the market to spot trends emerging within a day. When a trend is spotted, the trader buys either the stock, or options to buy/sell that stock. The positions taken during the day are usually reversed by the end of the day to limit the risk of holding the investment overnight, when it can't be sold on news. Day Trading is a very appealing lifestyle to people who don't need social contact all day and feel confident that can read the market.
If you are interested in this model of trading, then begin with your eyes fully open. Every day trader starts off over-confident. 40% of day traders quit within a month. 90% of them will have given up within a year, with all their funds exhausted. 13% of day traders claim a 6 month period of profitability, but only 1% are profitable over 5 years with half of them underperforming the market!
All this may sound like a lot of learning, a lot of time, and a bit too much bother for too little profit. If so, I recommend you find good mutual fund managers who do the work for you. To see how I found them for my clients, check out the
Investing in Growth Funds article.
