American actor and humourist Will Rogers once said, “There are three kinds of men. Some learn by reading. Some learn by observation. The rest of them must pee on the electric fence for themselves.” For obvious reasons, it’s far better to belong in the first two camps than the last. Here are some investing mistakes that have already been made by others so that we hopefully won’t have to repeat them again. 1. Using leverage to get rich quick Investing in the stock market is a way to build wealth slowly but surely. Trying to quicken the process through the…
American actor and humourist Will Rogers once said, “There are three kinds of men. Some learn by reading. Some learn by observation. The rest of them must pee on the electric fence for themselves.”
For obvious reasons, it’s far better to belong in the first two camps than the last. Here are some investing mistakes that have already been made by others so that we hopefully won’t have to repeat them again.
1. Using leverage to get rich quick
Investing in the stock market is a way to build wealth slowly but surely. Trying to quicken the process through the use of leverage (a.k.a. borrowed money) can be dangerous.
Warren Buffett and Charlie Munger are today a renowned duo of investors who sit at the helm of the giant American conglomerate and investment holding company Berkshire Hathaway. But, not many realise that in the earlier days of their career, Buffett and Munger were part of a trio with an individual called Rick Guerin.
According to Buffett, Guerin was every bit as good an investor as him and Munger. But, Guerin was in a hurry to get rich while Buffett and Munger were not.
To hasten his wealth-building process, Guerin invested with borrowed money. When there was a severe bear market in U.S. stocks in 1973 and 1974 (stocks fell by nearly half in that episode), Guerin had to meet margin calls as a result of his use of leverage to invest.
In order to raise the capital needed, Guerin was forced to sell his Berkshire stock to Buffett for less than US$40 apiece. Today, the same Berkshire shares are trading at US$192,200 each.
The stock market holds massive long-term potential but can be very volatile over the short-term. Those ups-and-downs, coupled with the use of leverage, can rob even the smartest of investors the chance to benefit from the long-term wealth-building capabilities of stocks.
2. Betting on macro-economic themes
If you knew a commodity’s price would more than triple over the next decade, you would think that purchasing shares of the commodity’s producers will be a surefire way to riches right? Wrong.
Gold was worth A$620 per ounce at end-September 2005. As of 15 September 2015, the precious metal has grown by 250% to A$1,550 (or nearly 10% a year). But, Australian gold miners have been a horrible investment as a group over the same period. To that point, the S&P / ASX All Ordinaries Gold Index, a market index made up of Australian gold mining stocks, has declined by nearly 4% per year from 3,372 points to 2,245.
There are many obstacles that stand between a growing macro-trend and a winning investment (the company’s business growth and its starting valuations are two such obstacles). As investors, we have to focus on the obstacles.
Along the same vein, while the price of crude palm oil had recently reached a six-year low, it does not necessarily mean that palm oil producers – like Golden Agri-Resources Ltd (SGX: E5H), Kencana Agri Ltd (SGX: F9M), and Bumitama Agri Ltd (SGX: P8Z), for instance – will make for a good long-term investment if and when the price of palm oil proceeds to rebound strongly.
3. Jumping in and out of our stocks
The legendary investor Peter Lynch once said that “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” He’s onto something here.
Investing research outfit DALBAR publishes an annual study called Quantitative Analysis of Investor Behaviour which compares the U.S.’s stock market returns versus investors’ numbers. Here’s a chart showing a compilation of DALBAR’s research results that’s prepared by my colleague John Maxfield:
Source: John Maxfield, Fool.com
As you can see, there are huge discrepancies between the returns generated by stocks in the U.S. and those earned by the average American equity mutual fund (the equivalent of unit trusts here) investor. The reason for the phenomenon, according to DALBAR, is that investors are simply inept at getting in and out of stocks – they do so at all the wrong times.
Financial advisor Nick Murray once said that “Timing the market is a fool’s game, whereas time in the market is your greatest natural advantage.” Those are really wise words to heed.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Berkshire Hathway.