If you have decided that investing is the route for you, there are a few basics that will enhance your ability to take advantage of Mr. Market. The most important one is this: Do your own work.
First, let me say that there are a lot of worthwhile resources available to investors. They provide the reader with wonderful starting points. After all, you have to generate your beginning ideas somewhere. But these resources are just tools. They help you get started.
If your goal is to surpass the average investor, however, then you really have no other choice but to roll up your sleeves and get started.
It's all about you
It is one thing for someone else to understand a business and pitch the idea to you, but that means nothing to you or your investment portfolio. Different investors have different goals at different times. The Warren Buffett of today, who invests in companies like Iron Mountain (NYSE: IRM), General Electric (NYSE: GE), and US Bancorp (NYSE: USB), simply cannot participate in the same investments as he did back in the 1950s and '60s. At Berkshire Hathaway's (NYSE: BRK-A) (NYSE: BRK-B) current size, a long-term 10%-15% annual rate of return would be exceptional.
When you start looking to fulfill your goals, remember that the best investment gems are usually waiting to be discovered, and are thus left ignored by the brains and media of Wall Street. This is a good thing, as the investor's goal is to get paid by doing his homework and not by taking on risk. There is no equity investment that is 100% free of risk. Your goal, however, is to get involved in situations where the odds weigh heavily in your favor. And then bet big.
Look at the bottom and not the top
Another reason to invest alone is that the crowd is always focusing on the Cinderella stocks of the day, such as companies like MGM Mirage (NYSE: MGM) and Bank of America (NYSE: BAC) that have recovered so strongly from their lows last year. Still, although many believe that these companies have put the worst behind them, buyers should heed Buffett's words that, "you pay a high price for a cheery consensus." If anything happens to derail the recovery, it could spell disaster for investors with newly acquired shares in these companies. Just ask anyone who bought stock in Crocs at 5-10 times its current price.
If you talk to analysts and all the other crowds that gather, the stocks on their lists are usually the ones with the highest degrees of optimism. Coincidentally, they also carry the highest levels of risk, as you will often end up buying at the top and selling at the bottom.
By acting alone, you will be able to focus on areas of the market currently unloved by the crowd without any distracting influences. One of the key tenets of successful investing is being able to buy a stock at the maximum point of pessimism, something that is rarely achieved if relying on crowd mentality. Had he relied on consensus opinion, Buffett would have never bought American Express in the midst of the so-called salad oil scandal. As history proved, the upside outweighed the possible loss of capital many times over.
Don't forget your circle
Of paramount importance in thinking independently is to remember to invest in only those situations that you completely and fully understand. Straying into untested waters without first understanding the underlying economics and potential risks will be costly.
By understanding your investments cold, you are less likely to be guided by emotional tendencies that tell you to sell a stock because the price has gone down by 20%, when nothing has happened to the underlying fundamentals of the business. The herd often likes to equate price volatility with risk, and you, thinking alone, will avoid such error.
Is Warren Buffett changing direction? Fool contributor Alex Dumortier explains how Buffett is idiot-proofing Berkshire Hathaway.
