The Motley Fool

10 Crucial Things to Know As an Investor

1. Dean Williams said in an investing speech in 1981 that “confidence in a forecast rises with the amount of information that goes into it. But the accuracy of the forecast stays the same.”

At the end of each year, Wall Street market strategists often forecast where the S&P 500 (a U.S. stock market barometer) will be at the next year’s end. According to my colleague Morgan Housel, from 2000 to 2014, the “strategists’ forecasts were off by an average of 14.7 percentage points per year.” Someone guessing that the market would climb by 9% per year (close to the U.S. market’s long-run rate of return) over the same period would have produced a forecast that was “off by an average of [only] 14.1 percentage points per year.”

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2. In 22 full calendar years from 1993 to 2014, the Straits Times Index (SGX: ^STI) has suffered a maximum peak-to-trough decline of 20% or more in nine calendar years. From 1993 to 2014, the Straits Times Index has more than doubled from 1,531 points to 3,365. Stock market declines are very normal. Keep this in mind whenever we experience market turmoil (like right now).

3. When describing market history, averages are often used. But, the stock market is a market of extremes.

For instance, the Straits Times Index had gained 4.7% per year in price from the start of 1988 to end-August 2015. But, from 1993 to 2014, there had never been a year in which the index had delivered a yearly return of between 3% and 5%; instead, there have been 11 years in which the index had chocked up a return of 3% or less, and 6 years in which the index had spiked by 19% or more.

4. Economist Erik Falkenstein once wrote that “in expert tennis, 80% of the points are won, while in amateur tennis, 80% are lost. The same is true for wrestling, chess, and investing: Beginners should focus on avoiding mistakes, experts on making great moves.”

Banking outfit J.P. Morgan released a research paper in 2014 showing how (a) 40% of all stocks in the Russell 3000 index in the U.S. since 1980 had declined by over 70% from their peak values, and (b) 40% of all stocks in the same index since 1980 had delivered negative absolute returns over their entire lifetimes in the stock market.

The prevalence of big money-losers in the stock market shows why it is so important for investors to know how to avoid mistakes when investing.

5. The more you trade, the less you may earn. Finance professors Brad Barber and Terrence Odean once studied five years’ worth of trading records from over 66,000 households in the U.S. and found that the 20% of households who traded the most underperformed the market by 6.5% per year on average.

An investment compounding at 6.5% annually can double your capital in 11 years. Think about that.

6. How long you can stay invested for can be very important in determining your odds of success.

Over the past 23-plus years from 1 May 1992 to 12 January 2016, the Straits Times Index had made losses 48% of the time for a 1-day holding period, 45% of the time for a 1-year holding period, 41% of the time for a 5-year holding period, and 0% of the time for a 20-year holding period.

7. Great long-term winners in the stock market can have above-average short-term volatility. From 20 November 2006 to 23 November 2015, shares of Riverstone Holdings Limited (SGX: AP4) had gained 769% in price alone. During that period, Riverstone had spent 8.7% of all trading days with a loss of 2% or more. The self-same figure for the Straits Times Index was just 4.2% of all trading days.

8. Investing does not reward us for extra complexity. Billionaire investor Warren Buffett once said, “I don’t look to jump over 7-foot bars. I look around for 1-foot bars that I can step over.”

9. It can be easier to make long-term predictions in the stock market than short-term ones. Investor Jeremy Grantham has a great analogy for this in financial journalist Maggie Mahar’s book, Bull: A History of the Boom and Bust, 1998-2004:

“Think of yourself standing on the corner of a high building in a hurricane with a bag of feathers. Throw the feathers in the air.

You don’t know much about those feathers. You don’t know how high they will go. You don’t know how far they will go. Above all, you don’t know how long they will stay up…

… Yet you know one thing with absolute certainty: eventually on some unknown flight path, at an unknown time, at an unknown location, the feathers will hit the ground, absolutely guaranteed.

There are situations where you absolutely know the outcome of a long-term interval, though you absolutely cannot know the short-term time periods in between. That is almost perfectly analogous to the stock market.”

10. In Singapore, the term blue chip stocks – referring to the 30 companies that make up the Straits Times Index – often carry positive connotations. But, a blue chip stock need not necessarily be a safe investment.

Shipping firm Neptune Orient Lines Ltd (SGX: N03) had been a blue chip stock since at least January 2008 until its removal from the Straits Times Index on September 2012. At the start of 2008, Neptune Orient Lines was worth nearly S$4.00 per share; today, it’s in the midst of being taken over at a share price of S$1.30.

It’s worth noting that Neptune Orient Lines’ profit had shrunk from US$83 million in 2008 to a loss of US$260 million in 2014. At the end of the day, it’s the business results which matter – not a company’s blue chip status.

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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 doesn't own shares in any companies mentioned.