[Today's Rule Maker originally ran October 18, 2000. We think it's a classic. Enjoy!]

I'd like to share five investment mistakes I've made, what they taught me, and how it can help improve my performance. If you need reminders why you shouldn't mimic what we do, read on.

1. Don't buy stock in a company simply because you believe its products add value to society. Make sure there's a market for what the company sells before buying.
A little over eight years ago, I lost my Mom to cancer at the youthful age of 53. Watching somebody I love die from that awful disease is one of the most difficult things I'll ever have to do. It was also one of the first things that got me interested in biotech stocks. I bought Cytogen Corp. (Nasdaq: CYTO), my first biotech investment, in August 1996 at about $8 1/2 per share. I sold in November 1997 around $2 9/16. I did my due diligence on Cytogen and believed the products it had in development would ultimately be approved. They were, but they fell in too much of a niche market. Getting the products approved didn't mean there was a market that would generate meaningful sales.

2. Analysts and fund managers tout stocks. That's their job. Don't factor the sales pitch into your decisions.
I started following Micron Technology (NYSE: MU) shortly after buying shares of Intel (Nasdaq: INTC) in May 1995 because I expected the demand for Micron's DRAM memory chips to explode. But, I hesitated because I thought DRAM chips were too much of a commodity. All the while I watched the price of Micron go up and up. Then it started to slide.

I read how Jeffrey Vinik, the former manager of Fidelity's Magellan Fund, was buying the stock. I figured if it was good enough for him, it was good enough for me. I bought shares at about $63 7/8 in November 1995 and sold them in December 1996 for $30 1/2. I also collected $0.38 per share as part of a lawsuit settlement when it was revealed Vinik had been selling shares of Micron at the same time he'd been talking it up in the press.

This was a defining event in my investment education. Now I do all my own research and make my own decisions.

3. Don't buy a stock just because somebody whose opinion you value likes its products.
In October 1996 I bought shares of Exabyte Corp. (Nasdaq: EXBT), which makes storage tapes and related products, at $15 5/16 per share. A relative told me his company used its products and that they were high-quality. I ended up selling in May 1998 at a price of about $10 7/8 per share, after the company missed earnings one time too many. Turns out there are other companies in the industry with better financial statements and products. They're also better investments. The lesson here is similar to #2, and I made both blunders around the same time.

4. Don't buy stock in a company if you're not interested in learning more about its business.
I don't have a horror story this time, just an experience that switched on a light in my investment mind. In November 1997, I bought shares of Applebee's International (Nasdaq: APPB) at about $22 1/2 per share. In July 1998 I sold for about $23. It occurred to me I had absolutely no interest in following this company or learning more about the restaurant business. As soon as I realized this, I dumped the shares. I didn't like the food much either.

Diversification is a concept that works for some, but I'd rather focus my investments on the companies and segments of the market that most interest me. There are so many opportunities that there's no real reason to spend your time learning about industries that bore you. Rather, focus on companies and industries that light a spark in your mind. Since I decided to narrow the types of companies I'd consider investing in, I've seen my returns improve. It ties in with my version of Peter Lynch's "Buy what you know" theory: Buy what you're interested in following and learning about.

5. If your research indicates a stock is no longer a good investment, sell it. Sometimes it's better to hold cash in your account than a stock you think has lost its edge.
Now for some controversy. I don't think you should hold a stock just because you're not sure where else to invest the money. We often say things like:

  • Don't invest until you've done your due diligence.
  • Wait until you're ready before investing in individual stocks.
  • It's better to take your time than plunge in just for the sake of investing.

If that works when you're just starting out, I don't see any reason you can't apply the same theory once you've started. If you think it's time to sell a stock, sell it. If you don't have a place to put the money immediately, that's OK.

There's nothing wrong with holding the cash until a better opportunity comes along. I purchased 3Com (Nasdaq: COMS) at $38 1/16 per share in February 1997. Later, when the stock was in the $40s or $50s, I decided it no longer met my investment criteria. I also had cash on the sidelines, so I decided holding onto my 3Com shares was better than adding to my cash balance. I ended up selling at about $29 1/16 per share in October 1999. I've come to realize this has been one of my biggest failings as an investor, and it's one I vow not to repeat in the future.

None of us are perfect investors. When we make mistakes it's important to realize what we did wrong and not repeat our errors. By doing that, we become better over time. With any luck, readers can learn from my blunders.

Phil Weiss, TMF Grape on the Discussion Boards