What makes the best investors so successful? It's not so much a matter of always picking the big winners, but having a set of knowledge and good investing habits that can make all the difference over the long run. With that in mind, we asked three of our top writers for a few things that smart investors never do, and here is what they said.
Matt Frankel: Smart investors don't trade too much. One of the worst things you can do is to overtrade your portfolio, that is, buying and selling in and out of stocks far too frequently. This can hurt your gains in a couple ways.
First, those commissions add up. And it's not just the immediate cost of your trading commissions, but the lost potential of long-term gains that results. For example, if you cut down on your activity by 10 trades a year, you'll save roughly $100 in commissions. Over a 20-year period, this could mean an additional $5,000 in your portfolio, assuming 8% average annual returns.
There are several ways to do this. Maybe instead of buying stock every time you deposit a couple hundred dollars in your account, let your cash build up and make larger trades. Or don't be so quick to sell your winning positions.
The second negative effect of overtrading is tax-related. If you hold your positions for a year or more, any gains are taxed at the lower long-term capital gains rates. On the other hand, if you jump in and out of positions frequently, holding them for less than a year, you'll be taxed on any gains at your marginal tax rate.
In a nutshell, smart investors buy and hold.
Jordan Wathen: Peter Lynch is one of the best investors of all time. His advice, however, to "buy what you know" can be dangerous.
There is a big difference between being familiar with a business and actually knowing a business. Here are a few examples:
- Marriott (NASDAQ:MAR) rents out hotel rooms, but it owns very few hotels. Operating hotel chains exposes you to different risks and rewards than owning and operating them.
- Visa (NYSE:V) and MasterCard (NYSE:MA) make money with credit and debit cards, but they aren't lenders. They only make money from the transaction fees; whether you pay your credit card bill is inconsequential.
- McDonald's (NYSE:MCD) makes burgers and fries, but it's not really a burgers and fries company. One of its CFOs once said, "We are in the real estate business. The only reason we sell hamburgers is because they are the greatest producer of revenue from which our tenants can pay us rent."
One couldn't be blamed for the assumption that Marriott, not McDonald's, is the real estate company. And it would seem reasonable that Visa and MasterCard have their hands in the 20% interest rate on your credit card, even if it's entirely untrue.
The point is simple: What you know as a consumer is often vastly different than what matters to investors.
Cheryl Swanson: While there's a rally for every season, there's almost always a correction or decline. Fortunately, corrections tend to be smaller than rallies, and that gives the stock market its long-term upward bias.
Genuine fortunes are made by taking advantage of financial corrections. While inexperienced investors panic and follow the herd, smart investors never make that mistake. Instead, they take advantage of declines to buy great, solid companies that are selling at discount prices.
The average bounce outdoes the average setback, particularly in the winter, when the market tends to come back with gusto. If you look at the seasonal gains in the Dow Jones Industrials, winters in the past 51 years averaged a 13 % gain as measured from the low in November or December to the first-quarter closing high.
The secret to wealth has always been to have faith in yourself, and to buy when the rest of the market is selling. Trust your judgment and take action during and right after corrections. As Abraham Lincoln said, "Things come to those who wait, but only the things left behind by those who hustle."