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When people hear that I write about investing, I usually get asked, "Got any hot stock tips?"
I always answer the same way.
"Yes, listen closely." (Looking around to make sure no one overhears): "Avoid stock tips like the plague. Do your own research."
While many people will spend hours agonizing over a new car, a laptop, or a cellphone, they often do zero research before investing thousands of dollars based on a recommendation from a total stranger or an article they read.
Don't be one of them.
What could possibly go wrong?
I can't stress this enough. The important part is to do your own research and look specifically for evidence that the investment idea is wrong. There are three reasons for this.
We'll see what we want to see: It's called "confirmation bias" or "positive bias." We have a natural tendency to look for evidence that supports our pre-existing notions and to remember information selectively. To prove something, you need to look for information that would contradict your beliefs and show your hypothesis to be incorrect. Ignoring information that shows your investment idea is a bad one will cost you dearly over the long run.
To be rational, you must look for fresh evidence that you are wrong or right. Most people only look for evidence that they are right and that their investment idea will be successful. Give as much thought to the risk as you do to the potential reward.
We'll assume it's smart and true because it was printed somewhere: Publication bias indicates that only "significant" research gets published, causing researchers to stretch and manipulate their findings to show the desired result and get published. In investing, you will rarely find investors writing that they think a particular stock is overvalued or fairly valued, as those articles don't get much play. You will mostly find articles claiming that certain stocks are undervalued.
There are multiple reasons for this. For one, looking for overvalued stocks or bad investments is nowhere near as exciting as looking for undervalued stocks and good investments. Second, negative findings are generally more closely scrutinized than positive findings. As a financial writer, I've found that people will generally overlook small errors in articles that are bullish on a particular stock. However, any article that's bearish on a stock invites harsh criticism. Commenters will call out the slightest errors and accuse you of being short the stock, while investor-relations people and even corporate executives will demand retractions. On top of all that, few people will praise you for writing negatively about a stock.
This effect is perhaps most obvious on Wall Street, where research has shown that only 6% of analyst recommendations are sell recommendations.
We'll believe we're right because, well, we just are: The overconfidence bias is the belief that your judgment and skill are better than others'. For example, 93% of people believe they are better-than-average drivers. This mind-set leads people to believe their decisions are based on objective ideas and that others are biased. A great example in investing came in 2013, when Deloitte found that 60% of chief financial officers of publicly traded companies thought U.S. equities were overvalued, yet only 11% thought their employer's stock was overvalued.
3 priceless tips
If you can avoid succumbing to the biases and faulty thinking spelled out above, you'll be a better investor for it. To further set yourself up for success, here are the three best tips I can give you:
1. Have an investing plan and focus on it
Do you have an investing plan? By that I mean a one-page document in which you commit to following a certain path with your investments. By drafting a plan that you understand, you are far more likely to follow it. And defining what you won't do is just as important as defining what you will do. That makes it far easier to filter all the noise and focus on what is important for your investing.
2. Constantly educate yourself
The secret to Warren Buffett's success is that he is a learning machine. Buffett is a far better investor today than he was 50 years ago. As Berkshire Hathaway Vice Chairman Charlie Munger has explained:
Warren Buffett has become one hell of a lot better investor since the day I met him, and so have I. If we had been frozen at any given stage, with the knowledge we had, the record would have been much worse than it is. So the game is to keep learning, and I don't think people are going to keep learning who don't like the learning process.
The saying "You can't teach an old dog new tricks" is a cop-out. In order to be a successful investor, you must believe that you can learn and grow.
3. Understand where others go astray
As Munger put it, "It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent."
People are loss-averse, overconfident, and impatient, and we need to learn to conquer those tendencies. We also come programmed with emotional responses that need to be further tamed by reason. We strongly desire short-term results. It's easy to get duped when you don't understand how a business works or how to value it.
Every time you're tempted to jump on a "hot stock tip," remind yourself that investing is a lifelong journey, not a sprint. An education in how to successfully invest for the long term is the best stock tip anyone could ever give you.
Dan Dzombak can be found on Twitter @DanDzombak, on his Facebook page DanDzombak, or on his blog where he writes about investing, happiness, life, and success.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.