The Ignorant Investor
Ignorance Can't Stand in the Way of My OpinionMonday, July 18, 2005
The Three Most Basic Rules of Investing
For no other reason than I think I should have these written down someplace and this place is as good as any other, the following are the three basic rules of investing that should keep me and any other ignorant investor out of trouble when it comes to investing capital:
1) Take your pile 'o gold and make two piles out of it: one pile is for risking in the market, and the other pile is for keeping. Make sure the second pile is protected from erosion in purchasing power by inflation, which means investing in some kind of bond fund and then reinvesting the proceeds rather than spending them.
2) When you invest in equities, only buy a stock if you're pretty sure the company is going to see earnings growth over the next few years that is way above average for the rest of the market and is currently undervalued by everyone else in the market. Otherwise you may as well invest the money in an index fund. You'll save yourself the headache of worrying about why your stocks aren't doing better than average and have the comfort of knowing that no matter what happens, most people aren't doing any better than you are. You'll also keep transaction costs down, and those are the costs that typically reduce the benefits of above-average returns generated by investing in individual stocks.
3) Don't trust the advice of brokers, pundits or financial magazines. Even assuming they aren't trying to bilk investors, they don't have advance knowledge of what the markets will do. There are literally thousands of people who claim to know what the future direction of the market or a stock will be, and some of them will turn out to be right. However, it's impossible to know who these people are beforehand.
Surprisingly, I find #3 the toughest rule to follow. When your money is on the line, it's hard not to respond positively to someone who promises to save you from your ignorance. I say to myself, "They're smarter than me, they know more than me, other people trust their advice more than they would mine- why not listen?" Well, because no one can predict the future, that's why. The only reason to listen to any of these people is when they're telling you not to do something crazy or stupid.
There are probably some other good rules I should list, but they're not springing to mind at the moment. I'll update the list as time goes on.
1) Take your pile 'o gold and make two piles out of it: one pile is for risking in the market, and the other pile is for keeping. Make sure the second pile is protected from erosion in purchasing power by inflation, which means investing in some kind of bond fund and then reinvesting the proceeds rather than spending them.
2) When you invest in equities, only buy a stock if you're pretty sure the company is going to see earnings growth over the next few years that is way above average for the rest of the market and is currently undervalued by everyone else in the market. Otherwise you may as well invest the money in an index fund. You'll save yourself the headache of worrying about why your stocks aren't doing better than average and have the comfort of knowing that no matter what happens, most people aren't doing any better than you are. You'll also keep transaction costs down, and those are the costs that typically reduce the benefits of above-average returns generated by investing in individual stocks.
3) Don't trust the advice of brokers, pundits or financial magazines. Even assuming they aren't trying to bilk investors, they don't have advance knowledge of what the markets will do. There are literally thousands of people who claim to know what the future direction of the market or a stock will be, and some of them will turn out to be right. However, it's impossible to know who these people are beforehand.
Surprisingly, I find #3 the toughest rule to follow. When your money is on the line, it's hard not to respond positively to someone who promises to save you from your ignorance. I say to myself, "They're smarter than me, they know more than me, other people trust their advice more than they would mine- why not listen?" Well, because no one can predict the future, that's why. The only reason to listen to any of these people is when they're telling you not to do something crazy or stupid.
There are probably some other good rules I should list, but they're not springing to mind at the moment. I'll update the list as time goes on.
posted by Worker 17 # 4:00 PM 
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