7 investment lessons from Mom. Part 1.
When economies and financial markets clearly go separate ways with economies all over the world searching for a bottom while financial markets flirting at their all time highs it's worth to refresh some basic rules how to safeguard your investment portfolio. And who is the best adviser if not... your Mom? I am sure your Mother has a saying, or an answer, for just about everything… as do most mothers. Every answer to the question “Why?” is immediately met with the most intellectual of answers “…because I said so”.
Seriously, Mother is a resource of knowledge that serves us well over the years. They may teach us the basic principles to staying safe in the world of financial investments too. Below you will find some basic rules every Mother teaches hers kids: read and re-read them. Then read again. I am sure they will help you to become a better investor.
NB The wisdom I'm sharing with you I found and kept for the future needs few years ago while browsing the internet. It was originally written by Lance Roberts, Chief Editor of the “Real Investment Advice” website, however, the link is not working anymore so enjoy it here. It’s a long read but worth your time.
1) Don’t Run With Sharp Objects!
It wasn’t hard to understand why she didn’t want me to run with scissors through the house – I just think I did it early on just to watch her panic. However, later in life when I got my first apartment I ran through the entire place with a pair of scissors, left the front door open with the air conditioning on, and turned every light on in the house. That rebellion immediately stopped when I received my first electric bill.
Sometime in the early 90’s, the financial markets became a casino as the internet age ignited a whole generation of stock market gamblers who thought they were investors. There is a huge difference between investing and speculating, and knowing the difference is critical to overall success.
Investing is backed by a solid investment strategy with defined goals, an accumulation schedule, allocation analysis and, most importantly, a defined sell strategy and risk management plan.
Speculation is nothing more than gambling. If you are buying the latest hot stock, chasing stocks that have already moved 100% or more, or just putting money in the market because you think that you “have to”, you are gambling.
The most important thing to understand about gambling is success is a function of the probabilities and possibilities of winning or losing on each bet made.
In the stock market, investors continue to play the possibilities instead of the probabilities. The trap comes with early success in speculative trading. Success breeds confidence, and confidence breeds ignorance.
Most speculative traders tend to “blow themselves up” because of early success in their speculative investing habits. The speculative trader generally fails to hedge against the random events that occur in the financial markets. This is turn results in the trader losing more money than they ever imagined possible.
When investing, remember that the odds of making a losing trade increase with the frequency of transactions being made. Just as running with a pair of scissors; do it often enough and eventually you could end up really hurting yourself. What separates a winning investor from a speculative gambler is the ability to admit and correct mistakes when they occur.
2) Look Both Ways Before You Cross The Street.
I grew up in a small town so crossing the street wasn’t as dangerous as it is in the city.
Nonetheless, I was yanked by the collar more than once as I started to bolt across the street seemingly as anxious to get to the other side as the chicken that we have all heard so much about. It is important to understand that traffic does flow in two directions and if you only look in one direction – sooner or later you are going to get hit.
A lot of people want to classify themselves as a “Bull” or a “Bear”. The smart investor doesn’t pick a side; he analyzes both sides to determine what the best course of action in the current market environment is most likely to be.
The problem with the proclamation of being a “bull” or a “bear” means that you are not analyzing the other side of the argument and that you become so confident in your position that you tend to forget that “the light at the end of the tunnel…just might be an oncoming train.”
It is an important part of your analysis, before you invest in the financial markets, to determine not only “where” but also “when” to invest your assets.
3) Always Wear Clean Underwear In Case You’re In An Accident
This was one of my favorite sayings from my mother because I always wondered about the rationality of it. I always figured that even if you were wearing clean underwear prior to an accident; you’re still likely left without clean underwear following it.
The first rule of investing is: “You are only wrong – if you stay wrong”.
However, being a smart investor means always being prepared in case of an accident. That means quite simply have a mechanism in place to protect you when you are wrong with an investment decision.
First of all, you will notice that I said “when you are wrong” in the previous paragraph. You will make wrong decisions, in fact, the majority of the decisions you will make in investing will most likely turn out wrong. However, it is cutting those wrong decisions short, and letting your right decisions continue to work, that will make you profitable over time.
Any person that tells you about all the winning trades he has made in the market – is either lying or he hasn’t blown up yet. One of the two will be true – 100% of the time.
Understanding the “risk versus reward” trade off of any investment is the beginning step to risk management in your portfolio. Knowing how to mitigate the risk of loss in your holdings is crucial to your long-term survivability in the financial markets.