You are Solely Responsible for Your Investing Success

Guest Post

It is quite unfortunate that the majority of investors approach investing with the mind set that they need to find stocks that will provide the greatest return in the shortest possible time. The entire day trading industry is built upon this need for instant gratification. Brokers are all too happy to fill this need by offering low trading commissions and beautiful charting and trading tools. As is often the case, constant portfolio turnover and churn is where the real money is for the brokers. “Making it up in volume” may not work for Detroit any more, but it works very well for the discount brokerage industry.

Investors who get seduced by these tools and the hope of a quick profit, tend to significantly under perform the market. Step back for a moment and consider this: The total market return (for example an index such as S&P 500) is the sum of the returns of all the individual investors in that market, institutional investors such as funds, less the commissions and fees they pay out to their brokers.

The problem is that of the three main participants in the market, individual investors are the only ones who are completely dependent on good stock picking for their profits:

1. Brokers: They typically do not care about which stocks are up and which are going down. As long as their customers are buying and selling, they make money in form of commissions and the spread between bid and ask. The greater the trading activity, the better it is for them.
2. Funds (mutual funds, pensions, hedge funds, etc.): Fees and expense ratios are the main source of income. Hedge funds do have a part of their fees tied to performance, but they are also guaranteed a part of their income as a percentage of Assets Under Management (AUM). Performance plays a role in attracting new customers but it is unlikely that the fund company will operate under loss as long as it has a good size asset base.
3. Individual investors: Completely dependent on the returns of their investments for their profit.

The intermediaries provide a service and get paid for it. Nothing wrong with it, except that the goals of an individual investor and the brokers/fund companies are not necessarily aligned at all times. The stock market may or may not be efficient, but I can tell you this – the industry is extremely efficient at extracting every cent of profit from the investing public – that is, from YOUR investment returns.

Fortunately, Successful Long Term Investing is Not Complicated

Your investing success depends on you, and no one else. No one has the same incentives as you do. It is not complicated, but unless you have a well defined process and the discipline to stay with it, it is going to be very hard. It also requires a change in the way most of us think about investing and stocks. Stop thinking about rate of return and beating the market and start focusing on a solid investment plan and process and your returns will take care of themselves. Use the following principles and you will be on your way to create a good plan that works for you.

1. Invest in businesses, not stocks – A stock is just a way of gaining a part ownership in a business. Do not think of a stock as a bet. Only buy stock in a company that you will be happy to run yourself if you were to own it outright. So you will need to think about profits, customer loyalty, growth prospects and competition. You should really consider all aspects of the business before you invest in it. Spend more time choosing your investments than you would, for example, in choosing a new microwave oven.
2. Do not over pay – It is one thing to buy a company that is profitable and has a strong competitive position. It is another to buy it at a price that will ensure profits for you. If you pay a premium for your stock, that is when the stock is overvalued, the company may continue to rake in profits and cash flow for the next ten years and your stock may not move. This is because over time, all stock prices approximate the intrinsic value per share of the company. However, at any given instant of time, the stock prices may be out of whack with the value as it is more dependent on the investor sentiment and the demand/supply of the stock in the market. You may want to read my thoughts on how to buy stocks at a discount to understand better how this process works.
3. Ignore the market, turn the TV off, cancel CNBC – If you are following the two principles laid out above, you are more 80% there. However, if you are the kind that panics when the market does, you are likely to sell off your good stocks at the worst possible time. If the investment merit of the stock has not changed, there is no reason to sell it. It is just better to tune out the unnecessary noise.
4. A down market is an opportunity, a buoyant market is scary – When your barber starts giving you stock tips, it is most likely the time to sell. When the IPO market heats up, sell. When everyone sells their stocks and hides their cash under the mattress, buy. When the number of new investing blogs in a year exceed the number of new “frugal” blogs, sell. You get the idea. The trick is to buy low and sell high. The days after the Lehmann Bros collapse were some of the best days to scoop up sound and profitable companies such as American Express.
5. Do not, and I mean this, do not be afraid of cash – It is surprising how so many investors feel compelled to buy a stock, any stock, if they have cash sitting in their brokerage account. The only valid reason to invest in a stock is if you have researched the business and decided it has investment merit. When the market is overvalued and there is a paucity of good investment values, it is prudent to stay in cash. Buying an iffy stock that eventually loses money is neither macho, nor sexy.
6. Get in with the correct process – The correct process, and the mind set for successful investing, is not to buy stocks that will go up. The correct process is to buy ownership in a company that makes money for its owners without overpaying for the share. Sure there may be times when you judge wrong, and there may be times when you have to be patient for years to profit, but if you do this long enough, with good number of stocks, you will eventually win out over the market and the average unenlightened investor. If you do not use the correct process, just know that there are many businesses out there just waiting for you to hand them your hard earned money.

If you have stayed with me so far, you are probably asking this obvious question: How do I find time and help to research the stocks and the businesses in the manner you are suggesting? In the old days, only investors with considerable assets, who could afford a full service broker and their custom advice, bought stocks. Today, technology and new financial products such as funds and etfs have brought in many new investors in the market and discount no frills brokers have thrived. The fact is, if you can’t afford good advice, you will have to make time to research your stocks. There is no way around this. Even if you have a good advisor, I recommend you do not buy any stock that you do not understand yourself. Then by all means take advantage of low commissions offered by discount brokers.

Shailesh Kumar, perhaps better known as Arohan, runs the popular value investing site Value Stock Guide where he doles out stock advice and recommends undervalued stocks to buy to new investors and stock market grey beards alike.

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