'How to Avoid Destroying Wealth'
Don’t Hang On to Bad Investments
Too many people hang onto investments that they bought a long time ago hoping that they will come back to the level that they were. Nobody likes to admit that a mistake has been made. Three of the most difficult words to say (besides “I Love You”) are: “I was wrong”.
Usually when I buy a particular stock in a company, there is a specific reason I am willing to pay money for it. It might be that I think a product will be more popular than anticipated, the company is worth more than the share price indicates, or there is big potential for growth in a market. As long as the reason that I bought the stock is still intact, I am willing to take small losses and maybe even buy more. As soon as you are sure that you are wrong, it is time to sell!
At the Best Investment Center, we don’t care what price a stock has sold for in the past, we only care where it is going to go in the future. To be honest, there are stocks out there that will NEVER get back to their high prices. Just because Krispy Kreme Donuts (KKD) once sold for $49.37 per share, doesn’t mean it will ever trade back in that range. In fact, in September of 2009 its share price was $3.37. If you recognized that they were expanding too fast, you could have sold before it tanked. I am pretty sure that KKD will never be that high again.
If you want to avoid losing huge amounts of capital, you will have to set some sell rules for yourself. I set my sell rules at 10%. If my stock goes down more than 10%, I assume that I have made a mistake and cut loses short. You cannot afford to destroy wealth on one stock. If you are wrong, you can gain back 10%, you will have a hard time gaining back 90% losses
You also need to realize that in order to gain back a 10% loss, you have to have a 11% gain. Not too bad, right? If you let it lose 90%, you would have to gain 1000% to get that loss back.
Let’s do some math. If you invested $1000 in a bad investment and you sold after losing 10%, you would still have $900 to work with. You only have to gain $100 dollars. But if you let it lose 90%, you would have to gain $900 back with only $100 left to invest. That is a hole you do not want to have to dig out of.
If you want to have the best investment portfolio, you must be able to swallow your pride and admit you have made a mistake. Sell before you lose too much value.
Don’t Invest on Advice Alone
Much money has been lost on following a friend’s advice, and almost all of them are “a sure thing” in their minds. I have heard one too many stories of elderly people who dumped some of their savings into an “investment opportunity” only to find that it was not a wise investment.
There is much more to investing than just finding a person that has done it before and taking them at their word. Anything bought on a whim is a poor investment, even if you make money. I like when James Cramer says, “I don’t believe in ‘buy and hold’, I believe in ‘buy and homework’.” Any investment can start with good advice, but the best investment is found when it is followed up with a little homework.
When you buy stock in a company, you are buying a piece of the company. You should understand how they make their money, what products or services they offer, how much money they bring in or lose, how much debt they have, and what the future looks like.
You do not have to pay someone to tell you this information. It is all easily accessible from any investment website. You can find a short description of the company by entering the ticker symbol (the 1-4 letter code for each company) into any website where you can get a quote. There should be an overview that describes how a company makes money. There should also be a link to see the company’s financials (Balance sheet) where you can find how much debt they have and most websites on the company profile will tell you how much earnings the company made for each share owned (EPS or Earnings Per Share). You should also be able to find out what paid people (analysts) think about the future of the company with a link as well.
Homework is not rocket science. If you just spend a little time getting to know the company before jumping on the investment bandwagon, you will find the best investment is the one that is not a fluke.