There is a saying that those who do not learn from history are doomed to repeat it. Fortunately, there are plenty of time-tested lessons every investor can employ to avoid the mistakes of others.
After a few years of relatively high investment returns, many investors have been lulled into thinking that investing is easy. So now is probably a good time to review some fundamental, and often overlooked, investing truths.
The first is: don't assume the market is always right. Even when information is transmitted instantly and widely, and pages of information are available through the click of a mouse, the market is often inefficient; prices don't always reflect the true value of investments. The fact that a popular technology company is trading at $200 per share does not make it worth $200 per share. Popularity is not the same thing as underlying value.
While following the crowd might work in the short term, it fails over long periods of time. Momentum investing (buying stocks that have already moved up) has worked well from time to time. But it can't keep working.
At some point, stocks become expensive and then they become absurdly expensive. Then they fall. Investors will do better by adopting the opposite of trend-following - understanding that price matters. Your objective as a successful investor is to pay less than a company is intrinsically worth as a business, in terms of its earnings and future prospects. To make this assessment requires a bit of independent thinking and analysis because, as per the first lesson, the market or the crowd doesn't always get it right.
You can't time the market. Legendary investor Benjamin Graham had a mathematical bent and spent much of his career trying to find a good formula for when to get in and out of the stock market. He ultimately concluded that all formulas failed.
Stocks should be bought when their price is lower than their intrinsic value and should be sold when their price is higher than their value. A long-term view should be adopted regardless of what is happening around you. Investors should not panic at short-term market developments. You should stick to a plan and remember why you invested in the first place.
This way you will avoid emotion overtaking reason. The market saying - 'it is time in the market, rather than timing the market, that matters' - has a sound foundation.
Diversification does work. While diversification is investing jargon, it basically reminds us not to stake our future on a narrow bet. We should spread our investments, preferably among assets and industries that behave differently from each other, so we maximise our chances of getting at least some of our investments right.
Diversification might mean, from time to time, part of our portfolio does not do as well as the market, which can be hard to swallow. But losses in part of our portfolio are a darn sight easier to cope with than losing our entire portfolio because our one or two favoured bets failed.
Speaking of losses, we shouldn't be afraid to take them. Mistakes are part of life and they will certainly be part of any investor's experience. Even the world's investment legends have made mistakes, routinely, but still managed to achieve great results over long periods of time.
The price you paid for an investment is a matter of historical significance. You paid based on the information you had at the time. But information changes and it is okay to change your mind when the facts change. Some investors think that averaging down - buying more of a losing stock as the price falls - is a logical strategy. It's not. It is simply a technique used to avoid admitting a mistake. When in doubt, get out.
Lastly, don't underestimate the value of common sense. History is a guide rather than a template. If something doesn't feel right, move on. If something sounds too good or too easy, it probably is.
If you can remain rational when others aren't, you will be well on your way to becoming a better long-term investor.
• Carmel Fisher is founder and managing director of Fisher Funds
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