In the lead-up to Sept. 25's Worldwide Invest Better Day, The Motley Fool is reacquainting investors with the basic building blocks of investing.
Yesterday, we held a roundtable asking a group of our top analysts for the best investment advice they ever got. Today, it's time for the flip side... the worst investment advice they ever got.
This may be even more fun. Here's what they said.
Dan Caplinger: The worst investment advice I ever got was from the full-service broker my parents used. He had me invest in a bunch of index-tracking mutual funds that included high annual fees as well as a back-end sales charge that locked me into the funds for several years. Later, I discovered I could get a nearly identical set of funds that would save me several hundred dollars in fees each year. In the end, I decided to pay a 2% sales charge in order to get out of the costly funds as soon as possible. But I've been critical of full-service brokers ever since, and the experience taught me just how important it is to reduce investing costs wherever you can.
: There's nothing wrong with diversification -- as long as it's properly done. But spreading out your investment dollars without a clear strategy is "diworsification" at its worst.
As a young investor, I was informed that my portfolio really needed more balance across both geographies and market sectors. After much hand-wringing, I picked a Japanese carmaker, an American megabank, a large pharmaceutical specialist, and some other things I barely understood.
These were some of my worst investments ever. When I finally closed out the last of my diversification plays, they had all gone sideways at best over nearly a decade. That's dead money, while I was handily beating the market in industries that made sense. My portfolio would be much fatter today if I had doubled down on the technology and media stocks close to my heart, rather than wasting my time on diversification for its own sake.
Matt Thalman : I was new to investing and talking with a co-worker. He claimed his brother was buying tons of shares of this little-known mining company that was about to hit it big. Sound familiar to anyone? So I go and buy a few thousand dollars' worth of this penny stock. For months nothing happens, then about a year later, cha-ching. In a matter of days the stock was up tenfold. (This was before I had been given the best investment advice ever and my emotions took hold. Greed! I made a good deal of money, but didn't sell when I should have.)
So if you haven't guessed it, I owned a stock, then coincidently it was pumped by a penny stock scam . So why was that the worst advice I was ever given? Because, still to this day, I know it was just dumb luck that I made money on this, but I still find myself looking at penny stocks from time to time. Dreaming of hitting it big again when I know I'd be better off burning the money I would invest in these stocks.
Morgan Housel : I've never owned a house. And I can't remember how many times I was told in 2005 and 2006 that, "You're throwing your money away!" by renting. I didn't take the advice to buy, but I came close. It was offered by so many people whom I admired. When everyone around you is making a fortune doing something you're not, you start to question yourself.
In hindsight, it was terrible advice. Tens of millions of Americans have seen their net worths destroyed by the mistaken belief that owning a home is always and forever a good thing. I think the belief persists to this day. And it's just wrong. The decision to buy a home is a complicated one that rests on how long you can stay in one area, how stable your job prospects are, the comparability of local rents, population growth in your town, and of course, housing prices. Owning makes sense for a lot of people, but it's not a slam dunk. Renting is a superior option for millions of Americans.
LouAnn Lofton : "You'll never make money in stocks. You're not smart enough, you don't know enough, and you're not trained in this." Thanks, but no thanks, Mr. Sneering Condescending Financial Advisor. I was young when I started investing, sure, but I didn't deserve that. Luckily, I'd already read about and been inspired by legendary financial gurus like Warren Buffett and Peter Lynch, (soon I would also learn about this amazing community of do-it-yourself investors called The Motley Fool) so I was not intimidated and I was not swayed by this guy's "charm." Ah, the pleasure I felt standing up and walking out of his office. I haven't looked back.
Anand Chokkavelu, CFA : Beware anyone's advice on their "love stock." When someone's enthusiasm for a company starts to sound like fanaticism for a sports team, the logic can get twisted and the objectivity can get nonexistent. That goes for our love for our own stocks as well. As an example, I love my shares of Accenture, but since it's my former employer I have to watch for nostalgia and familiarity clouding my judgment.
Molly McCluskey: Wait until you're out of debt before you start investing. What a terrible idea! In my twenties, I had student loan and credit card debt. Now I'm saving for a mortgage. Who knows what other expenses will come along. The trick is to keep investing in spite of them.
Had I been smart, I would have been socking away every little extra bit that came in from the second I finished undergrad. I would have gone to the movies less and rented more, packed my lunch, taken the bus, rented smaller apartments in cheaper cities, had more roommates, visited the bookstore less and the library more, and put all that money away. I would have developed the habit of investing, long before there was anything to show for it.
Tim Beyers : On the advice of a financial professional, I once bought a thinly traded penny stock. His pitch: The business was essentially trading for the cash on its balance sheet, making it a screaming value. And I bought it, hook, line, and sinker. What I should have realized is that cash comes and goes all the time. Genuine competitive advantage and skill in allocating capital, on the other hand, are rare. My shortsightedness cost me thousands of dollars that should still be sitting in my retirement account.
Eric Volkman : "Don't worry about it -- open a position! They own that huge asset and it ain't going nowhere; sooner or later, they'll have to turn a profit. Really!!" So said a colleague of mine about one particular company, the name of which I won't reveal (OK, OK, it was France/Britain's Eurotunnel). That asset (the Channel Tunnel) was a big and impressive one, all right, so much so that I cheerfully ignored the company's many other problems... plus the fact that it didn't technically own the tunnel. I bought a thousand shares. Wh-hoops! The problems deepened, the debt widened (yes, I ignored the Best Investment Advice I Ever Got), and the stock tanked. Which is what I get for not digging deeply enough into the operational and financial aspects of the company. Yes, Virginia, these are important. Lesson learned.
Chris Baines : "The trend is your friend." If I had a penny for every time I've heard this, I'd be a trillionaire. Unfortunately, this piece of "wisdom" is not true for any real investor. (I'll grant you, the trend is the friend of journalists looking for clicks.)
As an investor, the trend is not your friend, it's your worst nightmare. When the stock market peaked in 2000 the trend was up. When the stock market bottomed in 2009 the trend was down. Let valuations be your guide instead of letting a stranger's actions dictate your moves. That's what the best investors have historically done (I'm thinking Buffett and Peter Lynch) and will continue to do.
: "Be diversified" can be a useless bit of advice.
A lot of investors use the Peter Lynch "buy what you know" approach and buy shares of companies like Apple, Starbucks, Disney, and Coach and think they're diversified. After all, they've got technology, restaurants, entertainment, and apparel, a diverse-sounding group of sectors. But each of those sectors is highly dependent on consumers, so the true risk remains the same.
Even if an investor buys a broadly diversified S&P 500 index fund, his or her investments are still heavily weighted toward the United States, and even if an investor buys an even more diversified Morgan Stanley Capital International All-Country World Index fund, he or she is still betting everything on stocks, while ignoring other asset classes like bonds, real estate, and other alternatives.
Diversification as a concept is deceptively simple and lulls many investors into a false sense of security, but experts are still arguing over what risk is, exactly, and what diversifying means. The reality is that there is no magic wand to wave risk away, and while broad diversification is good, an investor should still be cognizant of the risks he or she is taking.
Tim Brugger : There was a time not so long ago when municipal bonds were high on my investment priority list. Limiting my tax bill -- even at the expense of longer-term growth -- was very appealing. It was my own, personal stand against the IRS and state tax man.
As I conducted my due diligence, I came across a local bond trader and decided to give him a shot. After discussing various laddering strategies and reviewing alternatives, he said something that still causes a snicker from me today.
"The great thing about municipal bonds, beyond the obvious tax benefits, is that it really doesn't matter if they're investment grade or not. I mean, it's not like a city or county is going to go bankrupt or anything."
Dan Newman : I started reading the ZeroHedge website about a year ago, and while entertaining and a good view from one extreme side of things, the main takeaway of buying gold, guns, and shelf-stable food would have severely underperformed the market. Pessimism about the economy will always be around, and should be considered, but if you squirrel away all your money, precious metals, and cans of beans and wait for the apocalypse, you may only be right once. Meanwhile, if you invest in value-generating businesses, you can help create wealth and a better society, and ensure your future until doomsday happens.
Evan Niu, CFA : Try to use technical analysis. As a former registered broker, I've had my fair share of experience with literally thousands of traders attempting to time the market by reading charts and picking up on technical signals. It's a losing proposition the majority of the time, in my opinion. A few will make it work, but far many will lose trying.
Andrew Marder : I'll probably repeat it until I die, but nothing has caused me more heartache than investing in companies that I know -- thanks, Mr. Lynch. It's my own fault, but I tend to really know, from actual experience, two kinds of companies: boring companies and banks. Here's a tip, don't invest in either of those two.
The first batch isn't so bad. I know Williams-Sonoma, and it's starting to do some really good things. I know Starbucks, but knew it best when it was flopping around like a missed fish at Pike Place. And I know Barnes & Noble. The second basket is less boring, and is instead a little nightmare. Not only do I know banks, I know British banks. Reading the annual reports requires a homemade Enigma Machine, and even then it's not always clear why the stock does whatever it does.
So I've tweaked that advice: Invest in companies that you, your oldest friend, and a college kid know. That should keep you out of the slowest, and most dangerous, stocks.
Keith Speights : The worst investment advice I ever received was that buying individual stocks was too risky. I held back from buying stocks and only put my money into mutual funds for years. While there certainly is a level of risk in buying stocks, risk exists with any form of investing. The better advice would have been to be aware of the risks in buying individual stocks and learn how to manage that risk (through diversification, for example).
Sean Williams : I know this might sound brutally counterintuitive, but the absolute worst advice I've ever latched onto was Peter Lynch's advice to "buy what you know." Now don't get me wrong, I whole-heartedly agree that you should be able to describe what the company you own does as if you're telling it to a child, but Lynch's investing mantra boxed me into researching a very small swath of companies.
Since abandoning Lynch's market view years ago I've uncovered an incredible number of gems that I would never have discovered had I not actively sought out new ideas, concepts, and technologies. Investing is a constant learning process and Peter Lynch's investing thesis was curbing that want to expand my investing universe.
Chuck Saletta : The worst investment advice I ever got came from a broker who talked me into a high sales charge, high ongoing fee, and high churn technology fund in the mid-1990s. I was still in school and wanted a way to invest my summer earnings, and he was very eager to turn my hard-earned cash into commissions for himself. The tech bubble was in the process of forming, yet somehow (probably due to the charges, churn, and fees), my fund never seemed to rise all that much.
Fortunately, I did sell the fund before the eventual tech bubble burst -- but not due to any incredible flash of investing brilliance. I simply needed a down payment for my car, and that was the only real savings I had.
Alex Dumortier, CFA : In the mid-2000s, I bought the shares of Journal Register, a publisher of local newspapers, after reading the analysis of a fundamentally oriented research organization. The thesis was that the shares were cheap enough to account for a heavy debt load and the secular decline of the newspaper business. The shares just got cheaper and cheaper and the research organization was forced to bring its valuation down multiple times. I ultimately exited the investment for a near total loss and the company filed for bankruptcy. This month, Journal Register filed for bankruptcy again. The lesson here is that no margin of safety is great enough when investing in a business with declining economics. That may not be an absolute rule, but behaving as if it were will spare you plenty of aggravation. There are easier ways to make money.
We hope you enjoyed the roundtable. Click on the button below for more on Worldwide Invest Better Day.