5 Things You Shouldn't Do

Investors the world over listen when 78-year-old Warren Buffett expounds on how to make money. I myself listen when my 94-year-old neighbor advises me on how to better trim my hedges.

There's a lot we can learn from those more experienced. And over the 15 years I've been investing, I've learned a few things worth sharing.

1. Don't think of stocks separately from their underlying businesses.
Stocks are not lottery tickets, despite what many day traders think. Yes, investing in a stock is making a kind of bet, but it's not a random bet.

Why? A stock is nothing more than part ownership of a company -- and you can learn quite a lot about that company before investing in it. In fact, you should. It will enable you to invest based on concrete information, instead of on momentum, rumor, or market volatility.

2. Don't fall in love with a stock.
If the marketing department is at all worth its salt, it's easy to read a little about a company and get very excited. But falling in love with a stock makes us less objective, more likely to look for green flags and less likely to notice red ones. And that, my friend, is a path to disappointment.

To help you stay objective -- even about stocks you currently own -- write down your buying and selling criteria and revisit them frequently. Make sure you bring those criteria to every buy, hold, and sell decision you make.

3. Don't conclude too much from one number.
Ratios, multiples, and other metrics are helpful measures of a company's health and performance -- but they aren't much good in isolation. Never rely too much on any one number, because numbers can be -- and are -- affected by everything from structural decisions (mergers, acquisitions) to analyst price targets.

Earnings per share, for example, can rise or fall not just because a company's net income rises or falls, but also if the company reduces or increases its number of shares. (The total drops when a company buys back some of its shares, and it rises when it issues new stock, perhaps to employees or via a secondary offering.)

A P/E ratio alone is similarly uninformative. It's better to compare a P/E with the historic range of the company's P/E. If it's now 20, but has usually been between 25 and 50, then it's looking attractive. If it's 20 and all its peers have P/Es between 10 and 15, then maybe it's overvalued.

So look at multiple metrics, dig behind the numbers, and make sure you put those numbers in industry and historical context.

4. Don't be impatient.
Once you've developed an investing thesis and purchased a stock, be patient. Short-term market movements often have little or nothing to do with the underlying value of the investment, so ignore daily fluctuations in favor of longer time horizons that will allow your thesis to unfold.

In addition, trading frequently can be costly. You'll rack up commission costs, for one thing. Trade twice a week and pay $10 per trade and it will cost you more than $1,000 just in commissions. You'll also pay higher, short-term taxes on your gains.

5. Don't judge performance out of context.
Returns matter -- but you don't know what they're saying unless you put them in a meaningful context.

Check out the following five-year returns, for example:

Data: Morningstar.com, March 11, 2009.

Sure, most investors would be pleased with Chevron's performance -- especially if they know that the market's long-term average annual return is around 10%. But what about Best Buy -- would you be happy if that had been in your portfolio over the last half-decade?

You should be. The S&P 500 averaged a 6.7% loss each year over the past five, which means Best Buy has outperformed the market by 4 percentage points on average. Oracle's 4% average is significantly better than it looks, outperforming the market by more than 10 percentage points. And Chevron, rather than being a ho-hum market tracker, actually outperformed the market by 17 percentage points.

So make sure you compare your returns to the relevant market benchmark -- it's the only way you'll know how well your portfolio really did. And if you find that you're not beating the market over time, then consider just joining it by investing in a broad-market index fund.

What to do
To be a successful investor, you need to do research, develop strong investing theses, and be patient as your theses play out in the real market. But what if you want to beat the market but don't have the time to research and track your investments?

Carefully chosen managed mutual funds can help you beat the market with less legwork on your part. How do you find those? Well, look for strong long-term track records, low fees, managers you respect who've been at the helm a good while, and managers who eat their own cooking. Infrequent buying and selling (as shown by a low turnover ratio) can also be promising, while a concentrated fund portfolio (one with relatively few holdings, such as 20 or 40) can lead to turbo-charged gains (and occasionally losses).

For detailed recommendations of top-notch mutual funds, I invite you to test-drive our Motley Fool Champion Funds newsletter (where I've found a bunch of winners for my own portfolio). Just click here to try the newsletter absolutely free, and you'll be able to read all past issues and read about every recommendation.

Longtime Fool contributor Selena Maranjian owns shares of Johnson & Johnson and Apple. Johnson & Johnson is a Motley Fool Income Investor selection. Best Buy is an Inside Value pick. Apple, Best Buy, and FedEx are Stock Advisor recommendations. The Fool owns shares of Best Buy. The Motley Fool is Fools writing for Fools.