The Importance of Having an Investing System
By
Paul Goodwin, Analyst and Editor of
Cabot China & Emerging Markets ReportFrom Cabot Wealth Advisory 3/10/08
Sign up for free Cabot Wealth Advisory e-newsletterStock market old-timers will often tell newbies that "the market wants to take your money," which, on the face of it, isn't all that credible. After all, lots of people make lots of money on Wall Street. Still, there's something to the warning, and the quicker you learn about it, the quicker you can start printing your yearly results in black ink, rather than red.
The education of a stock investor isn't exactly the stuff that Hollywood movies are made from. (No, that's not what the movie "Wall Street" was about!) There's not a lot of excitement in digging into business models, studying chart patterns, and tracking revenues and earnings.
Investing does have its moments, of course. I'm thinking specifically about how some of the action in the stock market in the past couple of months has looked like Matt Damon driving a Mini-Cooper down those stone steps in Paris in "The Bourne Identity."
And there are always a few exhilarating days every year when markets take off, giving you the same thrill that you got when the Millennium Falcon first went into hyperspace in "Star Wars: Episode IV."
But I digress. The point is that learning to invest in stocks isn't a barrel of laughs.
On the other hand, it's a tough world out there, with lots of people working more than one job and scrambling just to stay even with their mortgage and the bills...and not even managing that. It's hard to get ahead.
This feeling of powerlessness sends some people to convenience stores in search of lottery tickets or to a gambling casino, where the odds are astronomical (in the first case) and inexorable (in the second). In those cases, at least, people know the odds are against them.
Unfortunately, desperation also sends some people to the stock market...with the same results. People who go into stock investing in desperation often bring with them the same mindset (and the same lack of preparation) that accompanied them to the lottery window or the blackjack table. What they find out is that (as the title of this section notes) The Market Wants To Take Your Money.
Some people treat this truism as a general warning about equity investing. They don't believe that the market is actively, forcefully and intentionally trying to take their money away. They're wrong, and here are three reasons why.
1. Institutions want to take your money away. Large institutional investors control a wide majority of the equity capitalization in U.S. and global markets, and they count on individuals being both over-enthusiastic and over-discouraged. The individuals who push stocks up the last 10% or so to their tops are setting the table for institutions to sell and begin the stock's decline. And the last individuals who finally capitulate and sell a stock down to its low are tying a bow on the gift package for institutions, who will then quietly begin to buy up the discounted bargains.
2. The bandwagon wants to take your money away. It's hard to commit to putting a chunk of cash into a stock. As a result, a lot of investors wait to invest...and then they wait some more, trying to be sure that the stock they're buying is the real deal. Eventually, as the stock rises, more and more people are reassured by the stock's performance into actually pulling the trigger. It's fun to grab a piece of one of these stocks that's going through the roof, and some people actually make some money this way. But the last few people who jump on the bandwagon are doomed to go over the cliff with it. It's the law.
3. Good stories want to take your money away. Every great stock has a great story. Stories are how entrepreneurs win funding for their startups and how rising companies get the capital to expand. The trouble is that a lot of absolute mutts have stories that make them sound like the next Apple and Google and Microsoft all rolled into one. The guy who starts telling you about his favorite stock at a party will probably give you 95 cents worth of story with just a nickel's worth of information about the company's revenues, earnings and the performance of its stock.
There are other things in the market that want to take your money, but you get the picture. So what can you do about it?
As any of our longtime readers know, the answer is: Have a system.
If you like the idea of buying stocks at a discount and then holding on for years while they appreciate to fair value (the Warren Buffett way), then you are a value investor and you should follow that system. You'll make money.
If you're more comfortable with the idea of buying dividend-paying large-cap stocks that are closely tied to the progress of the U.S. or global economy, then you're a blue-chip buy-and-hold investor, and that's exactly what you should do. You'll make money.
If you cherish the thrill of finding hot, young stocks that are climbing like rockets and riding them to huge gains—and you can tolerate—and minimize—the losses that inevitably accompany this strategy—then you're a growth investor, and you should stick to your guns. You'll make money.
Whatever system you use, a strict sell discipline needs to be an integral part of it. If you ever forget that the market actively wants to take your money, the value of your portfolio will be glad to remind you.
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