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Investing Isn't a Lottery

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As investors, it's easy to play the "what if" game. If you'd only bought shares of some high-flying stock 10 years ago, then you'd be set for life. It would be like winning the lottery.

Dreaming of huge riches is part of the psychology of investing. At the same time, though, it's important to be realistic about your expectations, or else you'll fall into traps that could cost you your life savings. Instead, if you give yourself the proper outlet for your high-risk plays, you'll ensure that you'll be financially secure, even if you turn out to be wrong.

Assembling the perfect storm
In hindsight, it also seems as if stocks that produce lottery-like gains were destined to do so. Apple makes a good example. Looking at the mania over iPhones and iPads, it seems like common sense should have told everyone that Apple shares were a screaming buy when those products and their predecessors first came out.

But the key thing to remember is that a huge number of things have to go right for a stock to emerge from the thousands of peer companies that don't share the same level of success. For every blockbuster stock, you'll find dozens of companies that never even got to the point where they traded publicly -- and plenty of public companies whose ideas never really got off the ground. And there's no secret formula that says which one will win.

For instance, take priceline.com (Nasdaq: PCLN  ) . Coming out of the tech bust, the online travel site had lost 99% of its value. Competition from Expedia (Nasdaq: EXPE  ) and Orbitz (NYSE: OWW  ) seemed an insurmountable threat to priceline's profitability. But as it turned out, priceline's unique "name your own price" model made it a winner. Everyone involved in the transaction got what they wanted: Customers got lower prices, and travel-related companies got to shed excess inventory without broadcasting loss-leading promotions to their entire customer base.

In priceline's case, being first mover was a huge advantage. But in other cases, being early can cost you. Ballard Power (Nasdaq: BLDP  ) was a leading company in early fuel-cell technology, pioneering alternative energy that has now become much more prevalent. Yet in this industry, later-generation stocks such as First Solar (Nasdaq: FSLR  ) have provided the huge returns, while Ballard's share price has languished.

You can see this scenario repeat countless times in history. Dell (Nasdaq: DELL  ) and Gateway went head-to-head on direct-order computers, but only Dell emerged victorious from that fight.

Playing the big game
Even though you can't count on identifying the next multibagger stock, you don't have to stop trying. Even if you lose everything on several of your picks, it only takes one big winner to make up for those losses.

Now, it's true that by hedging your bets, you're essentially guaranteeing a certain level of failure. But by improving the odds of finding a winner, you'll stand to benefit far more often -- and greatly reduce your chances of suffering a catastrophic loss of investing capital.

In fact, many investors split their portfolios into two parts for precisely this reason. They have a core portfolio that might simply use broad-market index investments like the Vanguard Total Stock Market ETF (NYSE: VTI  ) as well as similar funds to cover other asset classes. But then, with a significant but not vitally necessary portion of their overall savings, they look at hundreds of individual stocks and choose the ones that look most promising to them.

Be a winner
Just like tossing a dollar at the convenience-store clerk might seem like your best chance to become a millionaire, betting everything on a "sure-thing" stock appeals to your inner sense of greed. But except for a lucky few, counting on finding a lottery stock is a losing proposition. You'll be better off balancing your desire for big gains with the discipline and certainty of a longer-term investing strategy.

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Fool contributor Dan Caplinger regularly finds winning lottery tickets littering the parking lot -- even if it's just a buck or two. He doesn't own shares of the companies mentioned in this article. First Solar is a Motley Fool Rule Breakers recommendation. Apple and priceline.com are Motley Fool Stock Advisor picks. The Fool has written puts on Apple. The Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (3)

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  • Report this Comment On February 09, 2011, at 3:46 PM, dickiedickieg wrote:

    Investing is not what i do - i trade, all day, every day and have made my living in this manner for almost 25 years. I am a proprietary trader and as such have traded all asset classes and in each of them there are only three rules to making a successful deal. These are timing, timing and timing.

    Whilst fundamentals may aid a long term strategy, choosing correctly when to invest and when to liquidate will seriously improve your wealth.

    Warren Buffet has succeeded by being greedy when others are fearful and fearful when others are greedy. In other words he times his purchases on a cyclical basis and fortunately has pots of cash to hide unrealised losses should he jump in too quick.

    Not sure if adding a link to a blog is within the rules so please only remove the following part if necessary and accept my apologies.

    There is much about timing trade entries and exits at www.thetradingarcade.com along with professional traders rants, moans, groans and foresights.

  • Report this Comment On February 09, 2011, at 10:02 PM, personalwm wrote:

    I would suggest this strategy is more speculation (in the true sense of the word) than long-term investing.

    If taking this home run approach, one needs to maintain stop-losses on the these. Not too light though as these are likely high volatility stocks that will fluctuate a fair bit. Perhaps 25-30% on downside.

    It is extremely difficult to pick the 1 home run stock; if it were easy, everyone would do it. So be careful.

    For true long-term investing, consider a passive strategy. Widely diversify between and within asset classes. Try to match the market performance. Minimize costs through low-cost brokers, ETFs, and no-load funds.

    For more investment information, please visit www.personalwm.com.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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