The 14 Truths You Must Know When You Invest

Less risky companies -- great companies -- must have lower expected returns. And those companies have much better earnings. Companies with great earnings are less risky. The only way you can get higher returns is if earnings turn out to be much greater than expected.

Think of it another way: If Wal-Mart and J.C. Penney go to the bank, who gets to pay a lower rate? Wal-Mart. The bank is willing to accept a lower rate because it's less risky. Why should it be possible that the equity would get a higher rate of return?

Truth 6: The Price You Pay Matters

The higher the price you pay for a stock, the lower the returns will be. Studies have shown that when the price-to-earnings multiple is above 22 on average, the stock's returns are less than 5%. When you buy a stock with a P/E below 10, the stock's return is about 17% on average. I talk about this in my book.

Higher prices don't necessarily mean the market is mispriced, but higher prices always mean lower future returns.

In the 1950s we lived in a high-risk world. We just ended the Second World War, we had the Soviet Union to worry about, and people didn't have very much confidence in the stock market. By 1990, we had no more war and no more Soviet Union, we were on good relations with China. By 1995, things looked even better. Eventually, prices got to be irrational. The problem is investors panic in both ways -- on the upside and the downside. People may have overreacted to Sept. 11, but we didn't know that was going to resolve itself OK.

Truth 7: Wall Street Deliberately Confuses Average Returns With Market Returns.

The market, the media and money management firms confuse the market returns with average returns. I know: You don't say to your children, "I hope you grow up to be average."

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