Mark Twain's $4 Million Mistake

"October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February." -- Mark Twain, Pudd'nheadWilson (1894)

Mark Twain was bankrupt by the age of 59, which undoubtedly contributed to his cynical view of stock speculation. His most famous investing disaster was at least a $150,000 loss -- $4 million in today's dollars -- on the Paige Compositor, an automatic typesetting machine that Twain believed would revolutionize the publishing industry. Investing in a product that would make printing faster and more efficient seemed like a no-brainer. He wrote to his brother at the time, "The Paige Compositor marches alone & far in the lead of human inventions."

Unfortunately, the inventor of the machine, Mr. Paige himself, was a perfectionist who refused to let the machine go to market until it matched his vision. By the time Paige was ready (14 years later!) to let go of his baby, more efficient and less expensive competitors had entered the market and rendered the Compositor impractical.

Don't bet the farm
We can all relate to Twain's enthusiasm to invest in a potentially paradigm-shifting product or company. If it pans out, it's a surefire way to amass a sizable fortune. On the other hand, if it falls on hard times, the results can be devastating. Consider the following:

Despite its inherent risks, speculation isn't altogether unhealthy. After all, had the Compositor succeeded, this article would be about Twain's investing genius, the universities he founded, the writing programs he endowed, and the charities he started.

Twain's biggest mistake was simply this: Investing more than he could afford to lose. It seems like a fairly obvious concept, but it is one that constantly gets overlooked by investors. We tend to focus so much on the riches that may await us that we refuse to consider the possibility of failure.

Smart speculation
No matter how revolutionary an idea may be or how great a company's management appears, it has to become reality in order to be profitable. Many obstacles can befall a company on the way to superstardom (e.g., FDA rejections, lawsuits, or SEC investigations), and some are more difficult to foresee than others.

To reduce the risk that unforeseen circumstances can have on your nest egg, hedge your speculative picks with some more conservative ones. For example, if your speculative pick is a tech company with a high beta, like JDS Uniphase (NASDAQ:JDSU) or Level 3 Communications (NASDAQ:LVLT), consider adding some dividend-paying blue chips such as McDonald's (NYSE:MCD), Novartis (NYSE:NVS), or Bank of America to your portfolio. These latter stocks are significantly less vulnerable to the market's whims or to zero-sum events.

Or, to instantly diversify your non-speculative equities, try an indexed mutual fund such as Vanguard 500 Index or an indexed exchange-traded fund such as SPDRs.

The Foolish bottom line
Your goal in investing (besides making money) should be to enjoy it -- and not risk so much that you get discouraged by crippling losses as Twain did. There's room in almost every portfolio for the great growth that paradigm-shifting companies can offer.

If you'd like some help finding a few ideas, let us help you select them wisely. Motley Fool co-founder David Gardner and his team at Rule Breakers specialize in finding growth companies that could fundamentally alter the frameworks of their industries.

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This article was originally published on July 19, 2006. It has been updated.

Todd Wenning owns shares of Starbucks. Starbucks and Palm are Stock Advisor choices. Bank of America is an Income Investor pick. The Motley Fool has adisclosure policy.