I was recently surfin’ some investing message boards and came across a great summary of the investment process. More specifically, it was a very simple description of the two kinds of mistakes an investor can make. It really hit home with me. When you filter the investment process down to its most basic level, there really is only two things that can make a good plan go completely haywire.
The two kinds of mistakes one can make in investing are:
1) Not buying a company that one should have bought
2) Buying a company that one should not have bought
Pretty simple if you ask me. How many times do you as an investor analyze a stock to death and like what you see only to sit on the fence and not commit any money to the company. I have. Many times these good companies go up in price.
And how many times have you bought a company that you realize after the fact you should not have bought. In this scenario, I am not talking about a company that looks good fundamentally and then goes through a decline only to rebound at some time in the future. I am talking about a company that you should not have bought in the first place because of poor fundies. bad industry, or other reasons. You just should not have bought the stock!! I know I have.
After a couple of decades investing in stocks I’ve come to the conclusion that my investment performance would be wonderful if I could have just avoided investing in the relatively few stock picks that did really badly. As it is, I think I achieved around the market average over time.
If I ever get enough spare time I plan on looking at the fundamental ratios of all the stocks I had bought and seeing if I could have employed some simple ratio rules to avoid most of the absolute shockers I bought, without eliminating any of the other stocks I selected.
The next step would be to work out how to best employ such a screening process – for example buying all the top 100 stocks, except those that fail the “stink test”, or perhaps combining an investment in an index fund with short-selling of the “stinkers”?
I’d argue #2 is a lot more important than #1. The worse case scenario with 1 os that you miss out on potential gains. But The worst case scenario with 2 is that you have an actual loss.
Another thing as well is selling or not selling when you should. Of course that is after you have avoided the first two mistakes!
These 2 looked more like remarks on hindsight than mistakes. There is no way to predict what will happen if you buy or don’t buy.
Mistake is when you don’t make the proper research and start to make decision on buy or don’t buy based on feel or following the crowd. If you have done the proper search and make the decision but the market goes against your decision, it is not a mistake. It is just part of life.