FOOL ON THE HILL
Warnings for Investors

Warning: Investing may be dangerous to your wealth. Just as cigarettes and aspirin come with warnings, the world of investing also warrants some cautions. For example, you may not know enough. You need a sell strategy. The next 10 or 20 years will probably be different from the last 10 or 20 years. Read about some warnings and contribute some of your own!

Format for Printing

Format for printing

Request Reprints

Reuse/Reprint

By Selena Maranjian (TMF Selena)
February 28, 2002

"We have not the motive to prepare ourselves for a "life-work" of teaching, of social work -- we know that we would lay it down with hallelujah in the height of our success, to make a home for the right man. And all the time in the background of our consciousness rings the warning that perhaps the right man will never come. A great love is given to very few. Perhaps this makeshift time filler of a job is our life work after all." -- Ruth Benedict (1887�1948), American anthropologist

According to the Columbia World of Quotations, Ruth Benedict wrote the passage above in her journal in 1912. At the time, she was teaching in a girls' boarding school. Two years later, she married a biochemist and eventually became a famous anthropologist. Given that her thoughts are nearly 100 years old, perhaps we shouldn't be dismayed at their pre-modern nature. Instead, her warning actually strikes me as more interesting. In our investing especially, we need to keep many warnings in mind.

Here are some warnings. If you haven't given them much thought before, do so now.

Warning: You may not know enough
It's true that you don't necessarily need to know much in order to invest in an index fund and reap market-average returns. (Remember that there are other kinds of index funds, besides S&P 500 ones. "Total stock market" index funds are well worth considering, as they include not just the biggest companies, but also small ones, many of which can grow a lot faster than giants can.)

But if you want to do better than average, if you want to be a gruntled investor, you'll probably want to learn how to find promising companies, how to evaluate promising companies, and how to decide which ones to buy into. A little knowledge is a good start, but the more you learn, the fewer mistakes you'll make and the better you'll likely do. (Resources: The Fool's School, The Motley Fool Money Guide, and for more interactive, structured learning, our Fool seminars.)

Warning: In many ways, investing is more complicated than it appears
I addressed this topic in an earlier piece on contradictions in investing. As you learn more about investing, don't be surprised to run across valuable insights that clash with other insights. For example, through your reading you might have concluded that if you're a long-term investor, you needn't pay much attention to the overall economy, aiming to hold on to great stocks for years, through ups and downs. Fair enough. That does make sense. But it's not necessarily so simple. Paying attention to the economy can also be worthwhile. If interest rates are falling, for example, and home sales are rising in response, then as you study companies in which to possibly invest, you might include those firms that will benefit from home sales -- such as Home Depot (NYSE: HD), Sherwin-Williams (NYSE: SHW) or Williams-Sonoma (NYSE: WSM).

Warning: You need a sell strategy
This is a lesson that many investors wish they'd learned earlier. (Even Fool portfolios have suffered by not having well-defined sell strategies. Keep an eye on our Rule Maker portfolio, as it develops one in the near future.) Too many of us spend most of our energy figuring out what to buy and when to buy it. Once a holding is nestled in our portfolio, we often forget about it to some degree. Or we keep an eye on it as it rises or falls, without thinking about whether we should sell it at some point. I know from personal experience that this isn't a good idea.

You need to have some kind of selling strategy in place. Your strategy might be one or a combination of the following (or something else):

-- Sell once the stock surpasses its intrinsic value.

-- Sell once you reap a 30% gain (or a 10% gain or a 50% gain or whatever you want).

-- Sell when a company's financials are deteriorating.

-- Buy to hold, meaning you buy with the intention of holding for many years, but you sell whenever you lose faith in the company.

-- Buy to hold, but sell when you find a much more compelling investment.

Warning: The next 10 or 20 years will probably be different from the last 10 or 20 years
This point is obvious when you think about it, but too often we just don't think about it. I can't tell you how quickly or sluggishly the stock market will grow over the coming decade, but I can tell you how it has done over many past decades. It tends to grow by an average of about 11% per year. But for the next 10 or 20 years, for all we know, it might average 7% or 13%. It's very likely that the growth rate of the '00s will differ from the growth rate of the '90s and the '10s. The precise 20 or 30 years that your money remains invested for retirement will offer different returns than other 20- or 30-year periods, such as ones that begin or end just a few years away from yours. So go ahead and keep that 11% figure in your head as handy historical information, but don't expect to earn exactly that in the years to come.

Scott Burns has written a good article on this topic, and Warren Buffett has shared his thoughts on what we might expect from the stock market in the coming years.

Warning: Ignore tax implications at your own peril
I know, I know. Just the word "taxes" is boring. Believe me, I used to think so, too. Then I was tasked with co-authoring our first tax guide. When working on it with TMF Taxes, I discovered that the world of taxes, instead of being excruciatingly, life-force-drainingly dreadful, is actually almost interesting!

It's a good thing, too, because we all need to give our tax situation some thought -- throughout the year, not just in mid-April. For example, if, when you sell your home, you take care to make sure that you qualify, you can exclude up to $250,000 ($500,000 if you're married) of your gain from taxes. That's tens of thousands of dollars of savings. There are also many tax credits you might enjoy, if you know about them. These include credits for education expenses, adoption costs, and childcare, among other things. There's much, much more to know -- and more to save.

Enjoy the informative, understandable and amusing explanations of many tax topics provided by TMF Taxes in our Tax Strategies area and in our handy Motley Fool Tax Guide 2002. The IRS's own website is also helpful (and even amusing in spots). And you can ask tax questions and get answers at our Tax Strategies discussion board.

Warning: You shouldn't necessarily avoid managed mutual funds
It's true that we've spent much time at the Fool pointing out how the majority of mutual funds may not deserve your dollars. It's true also that index funds will serve most investors very well. Still, if you hope to do better than average and you don't want to put any or all of your money in individual stocks you select yourself, then it might be worth spending some time finding one or more outstanding mutual funds. Because they do exist.

Here are just a few funds whose managers are admired by Fool HQ folks and who have solid track records:

-- The Legg Mason Value Fund (ticker: LMVTX), run by William Miller III

-- The Longleaf Partners Fund (ticker: LLPFX), run by Mason Hawkins

-- The Mairs & Power Growth Fund (ticker: MPGFX), run by George Mairs III

-- The Oakmark Fund (ticker: OAKMX), run by William Nygren

If you want to learn more about any given funds, you can access very informative reports on many funds at Morningstar.com. Also, click over to the website of each fund's parent company, to read the fund's prospectus and other material that will give you insights into the fund managers' philosophy. Many mutual fund managers are rather Foolish in their investing, keeping their fees, turnover, and number of holdings on the low side.

And finally...

Warning: You're missing out if you aren't checking out our discussion board community
You'll get much more out of your Motley Fool experience if you spend some time on our discussion boards. It's true that we've recently begun charging a modest annual membership fee for access to our online community, but you can check it all out via a free trial, if you're not already a member. Here's a long list of about a hundred boards on all kinds of topics, from sports to cooking to quitting smoking to astronomy, grieving, television, golf, poetry, religion, divorce, the military, gardening, parentnig, politics and... oh, yes -- investing!

I invite you to share your thoughts about these warnings on our Fool on the Hill board. Maybe you can add some more warnings? Maybe you have some terrific mutual funds to recommend? Maybe you can tell us more about Ruth Benedict? If so, let's hear it!

History is a vast early warning system. -- Norman Cousins

Selena Maranjian wishes more things in life carried warning labels. She owns no stocks mentioned in this article. To see Selena's complete stock holdings, view her profile. The Motley Fool is Fools writing for Fools.