If you have ever said -- or even thought -- any of the following, you need to re-examine your investing philosophy. 1. 'I love this company.' This is the statement that gets investors into more trouble than any other, and here's why: You are not buying a company -- you're buying stock in a company. There's a universe of difference between the two. Warren Buffett of Berkshire Hathaway ( BRK.A) buys companies; Cisco Systems ( CSCO) CEO John Chambers buys companies. When Jack Welch was running General Electric ( GE), he bought companies. Mere mortals such as you and I -- we only buy stock. It is arrogance to imagine you are purchasing anything more than a one hundred millionth of an ownership stake (or less) in these firms. The action of that equity is much more important to you as an investor than your personal affections for the entire company. Microsoft ( MSFT) is a good example of this -- in 2002, you could have paid as much as $35 (postsplit) or as little as $20 per share. It's still the same company, but at the recent price of $26, one buyer is up 30% while the other buyer is down more than 25%. Same company, different entry prices for purchasing the stock. That's why pricing and timing are so important. Loving a company will not make up for a bad buy. Unlike VCs and corporate chieftains, we don't get to buy business models. 2. 'I am a long-term investor.' The most astute thought ever put to paper about this statement was the classic quip by John Maynard Keynes: "In the long run," Lord Keynes said, "we are all dead." The long dirt-nap aside, being long term does not mean abandoning the responsibility to set reasonable sell triggers on both the upside and the downside. Long-term investors should still review their holdings monthly (if not weekly) for various sell signals.
It's important to listen to what a stock is telling you. The long run is not an excuse for riding profitable positions all the way back down to break-even or worse. I like to use a trailing stop for these types of holdings (i.e., Altria Group ( MO) or Exxon Mobil ( XOM)) to prevent giving back all the hard-won gains. Consider this: The employees of Lucent ( LU) and Enron had loaded their own 401(k)s with their respective companies' stock; they thought of themselves as good long-term investors. 3. 'I just heard on CNBC (or CNN or Bloomberg) that...' This is the kiss of death. Every trading desk in the known universe has CNBC (and CNN or Bloomberg) on in the background. They have screamingly powerful computers and wicked-fast T3 lines. They do this all day, every day. Unless you are among the fastest of the fast, by the time something hits CNBC, it's all over but the crying. The lower-risk/easy trade is over by the time an item hits the airwaves. The reason it's on TV in the first place is that initial move -- that's what catches the attention of the producers. By the time it hits the financial shows, the news is already "in the stock." Savvy traders are known to short into any temporary, TV-induced pop. My head trader is fond of an expression: "Last man in pays for beer." Chasing the latest hyped stock is a sure way to foot the bill for everyone else's drinks. 4. 'I don't want to pay capital gains taxes.' I consider this to be the single dumbest thing ever said by any investor anywhere. Period. I cringe each and every time I hear this shockingly ignorant statement. There is simply no worse reason to continue holding a position than to avoid taxes.
Once you've maxed out your tax-deferred accounts, your goal should be to pay all the capital gains taxes you possibly can; lots and lots of 'em. I'm reminded of an incident from '96: A friend of a friend had a huge position in Iomega ( IOM). They owned tens of thousands of shares at an average cost around $5. The stock had split repeatedly, 5 for 4, then 3 for 1, then 2 for 1. This individual was sitting on what was rapidly becoming an institutional-sized position. I asked when they wanted to sell, and got the classic answer: "Do you know what sort of tax bill that would generate?" At the time, the stock was skyrocketing. At $50, it went parabolic. I watched this entire move, swearing I would not butt into someone else's trade. Finally, the stock went vertical, with the third exhaustion gap -- a sign that the buying frenzy was peaking. My willpower gave out: I pleaded with them to convince the holder -- not even a client! -- to at least lock in partial profits. "If you're not going to dump all of it, then at least sell half -- for crying out loud, lock in something." All to no avail. It's a shame when someone makes a trade of a lifetime and then blows it because of greed. The cliche is true: Bulls make money, bears make money -- pigs get slaughtered. 5. 'I'm waiting for the stock to come back to break-even.' If you bought a stock which is now underwater, there are likely legions of people waiting for the same break-even point to get out. That's what the technicians mean by "overhead resistance." In fact, much of technical analysis is based upon the psychology of people waiting to get out of -- or into -- a stock at a previously missed price. When a stock dips and then rallies, those who missed the previous low price wait for another opportunity to buy it there. That why it's called "support," and it's why buyers seem to appear at the same price on a chart in a given stock. The reverse is true of sellers. Cisco is having a tough time getting through $24; every time it dips, holders kick themselves for missing that sale opportunity. "If it only goes back to X, I'll sell there" is practically a mantra. Once a stock "breaks out" through that resistance -- preferably on big volume -- the supply of stock is exhausted at that level, and it's clear sailing to the next resistance level. For Sun Microsystems ( SUNW) that number is $5.50, for EMC ( EMC) it's $15.50, and for Microsoft it's $30. These levels are the reason why traders follow "breakouts" -- and why some stocks have such trouble returning to your break-even purchase price.
DenouementThese "words of wisdom" reflect poor decision-making on the part of investors. These fables and legends contribute to investment behaviors that can reduce gains or cause big losses. They do not contribute to a person's financial well-being. In a forthcoming column we'll take a closer look at the other five top (or bottom) things you might say and do that ultimately undermine your investing success.
|1.||Expect to Be Wrong||2.||Your Fault, Reader|
|3.||The Wrong Crowd||4.||Bull or Bear? Neither|
|5.||Know Thyself||6.||Prepare for Battle|
|7.||Bite Your Tongue|
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Apprenticed Investor series