Common investment sayings are not a good basis for making investment decisions.
A few days ago, Padraig O'Hannelly wrote Expanding Your Investment Horizons with a suitably sceptical take on the expression 'Buy what you know'. That investment strategy can lead to what used to be called 'home bias' -- the habit of sticking with something just because it's familiar.
There are plenty more investing proverbs, sayings, rhymes and mantras that can be given too much importance, or can be taken out of context, or are simply wrong. Here are five more of them:
1. Hold for the long term
Just because a share has gone up or you've had it for a long time, that doesn't mean it's time to sell. Over-trading is a regular problem for active investors, many of whom would have been better off finding quality companies at good prices and sticking with them through good times and bad.
Yet this mantra of holding on through thick and thin can be taken too far, especially when it's not used in context of the value or quality of a company. If the business no longer looks like it's going to increase its value at a reasonable rate, then it may be time to let go.
Furthermore, holding it is going to be increasingly risky, particularly if it's not a great business, once it has surpassed what you reckon its fair value is.
2. Sell in May and go away
In recent decades, the stock market has usually performed better from October to April than from May to September. That's why we have this saying to sell in May and buy again on St Leger Day.
The theory behind this is that the City tends to hibernate over the summer season, what with all the important sports and social events that simply must be attended. There are less people buying stocks and doing deals, so the market just waddles along quietly during this time. This may have been true in the 1950s but it looks a little dated now.
Another problem is, in most years, the stock market has still risen during May to September, even if it hasn't been by as much. Furthermore, once you deduct trading costs from having to sell and then buy again, you'd be even worse off.
3. Run your profits and cut your losses
The more an investment rises in price, the more risky it becomes. This is a theme that many investment sayings seem to overlook.
Once a stock has gone above fair value, it becomes particularly risky. Other companies that are at or under fair value are safer homes for your cash and are more likely to have upside potential.
Meanwhile, as a share goes down in price it usually becomes less risky. The greater the discount to its fair value, the more likely it is to perform satisfactorily in the future.
It makes no sense to cut your losses on an investment purely because it's even cheaper. They may be a reason for it falling in price of course, so you need to investigate and decide whether the business has taken a turn for the worse or the fall is just market 'noise'. In other words, it's crucial to distinguish between price and value.
4. The trend is your friend
In many ways, this is similar to #3. Relying on the fact that a price will continue to rise (or fall) is generally a poor investing strategy.
However, if we switch the focus of this expression from its traditional interpretation -- the price trend -- to say, the earnings trend, we can get something a little more useful out of it. Investors like to see that, over many years, a company has remained profitable and continued to grow.
5. Diversify your investments
Diversification offers protection. We can all make mistakes and we can only estimate the value of a company, which is why you shouldn't put all your eggs in one basket.
However, it comes to a point where you have too many investments. A 100% gain in one share when you have 50 in your portfolio of equal size will increase your portfolio by just 2%.
Most investors should probably aim for around 10-12 quality picks. When you start going over that, diversification can dilute your gains. Your attention is spread too thinly as well and, as most investors would agree, even finding 12 investments you think are great value can be a struggle.
A proverb that happily isn't true
A common proverb is 'Hard work is its own reward'.
Thankfully, for dedicated, knowledgeable stock pickers with good judgement, hard work is not the only reward for doing hard work. Superior investment returns are the reward. So don't substitute hard work with the sayings in this article!
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