Are you one of those people frustrated with your inability to beat the stock market? Despite watching CNBC and Jim Cramer religiously, and reading The Wall Street Journal every day, you just can't seem to make it happen. Here are five ways I think that investors shoot themselves in the foot.
1. Do little or no research before buying a stock.
Would you trust a stranger to take care of your kids or drive your car? Then why would you entrust your portfolio, your hard-earned money, to the hands of management teams and businesses that you hardly know?
If you want to speculate, head to Vegas. It's more fun losing money in a casino than in front of your computer. While you're at it, you could do a little research on casino stocks such as Wynn (NASDAQ:WYNN), Las Vegas Sands (NYSE:LVS), or MGM (NYSE:MGM), and you'll see that the house always wins.
Remember, every time you buy a stock, there's someone on the other side of the trade. Consider these other people the "house." If they know more than you about the stock, you're at a disadvantage.
2. Buy stocks based on tips and rumors.
In my life, I've gotten two tips that could be construed as insider information, which I declined to act on. Both tips were of the "I have a friend, who knows a guy, whose cousin" variety. Anyways, I checked out the tickers about a year after hearing the tips, and both had plummeted. In fact, I just looked at the tickers right now, and they're both trading at multiyear lows.
3. Be an envious investor.
Charlie Munger often states that the worst of the seven deadly sins is envy, because other sins, like lust or gluttony, provide the sinner with pleasure. Envy, on the other hand, has no pleasurable aspect whatsoever.
I blame envy for a lot of things. I think envious investors bid Amazon (NASDAQ:AMZN) up to $400 per share. I think envy drove Shaq and Kobe apart and effectively dismantled the Lakers dynasty. I also think envy causes the average investor to get swept up into bull markets and decimated in the subsequent crash.
4. Invest with low conviction.
Doing a lot of research doesn't help much if you don't stick around to reap the benefits. I think investing without conviction is like marrying someone you just met a week ago. After the initial honeymoon phase, failure awaits after the first set of speed-bumps.
When investing in stocks, I can almost guarantee you won't catch the bottom. There are just too many random factors involved in the collective buying and selling activities of millions of people around the globe.
In fact, I think investing without conviction almost guarantees failure. Let's say you were smart enough to figure out that Apple (NASDAQ:AAPL) was a bargain back in 2001, and bought in the $10-12 range. The stock had cratered more than 70%, so investors could reasonably think that was the bottom of the barrel.
Unfortunately, everyone who invested in Apple's stock in 2001 would've seen their investment fall around 20%-30% over the next year. They'd also have to wait nearly two years just to get back to breakeven. Many investors would not have the conviction to ride out this storm, and would have bailed out at a loss. However, those with conviction who held on would be sitting on 13-baggers, with the stock currently at $130 per share.
5. Fail to separate price from value.
Oddly enough, we have no problem distinguishing between price and value at the mall. We don't say, this Gucci handbag is worth $3,000. We say, wow, that handbag costs $3,000. What a rip. At the mall, we know that the price people want us to pay, and the value we receive, can be two very different things.
The same rules apply to the stock market. Every year, Warren Buffett provides some commentary on how Berkshire Hathaway's (NYSE:BRK-A) (NYSE:BRK-B) stock performed. Then he talks about how its intrinsic value performed. Sometimes the two move together, sometimes they don't -- in other words, they're two very different things.
The investor who fails to discriminate between price and value fares no better than the tone-deaf contestant in American Idol. Both lack vital ingredients for success.
Final thoughts
So there are a couple of examples of what not to do. If you eliminate as many bad investing habits as possible, you might just turn into a great investor.
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