I first discovered how to invest in stocks at age 18, hesitantly making my first trades in 1986/87. Initially, I seemed to be a born investor, as every share I bought shot up in value. But then came Black Monday (19 October 1987), when global stock markets crashed spectacularly. This was when I started to understand this saying: “Never confuse genius with a bull [rising] market”.
How to invest in stocks badly
Today, after 35 years of investing, I have a solid grasp of the basic rules of how to invest. Also, thanks to the many mistakes I’ve made, I know how to invest poorly. And painful experience has shown that, for me, these were the five worst ways to invest.
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1. Running a concentrated portfolio
Two of my largest-ever portfolio losses — both well into six figures — came from a lack of diversification. In other words, I failed to spread my money around enough. By investing too much in too few stocks, my capital took a big hit when businesses got into trouble. Today, I would never invest more than, say, 10% of my money in any one stock — no matter how highly I rated it.
2. Magnifying returns using leverage
Leverage is using borrowed money or financial derivatives to magnify one’s gains. But leverage is a double-edged sword, because it magnifies losses as well as gains. When my leverage went wrong in the past, it cost me plenty. For example, I once bought a bunch of shares ‘on margin’ via my broker. When the share price crashed, I lost all of my money, plus another £40k on top. And that’s why it’s been a dozen years and more since I’ve employed leverage in my portfolio.
3. Failing to sell losers
Back in the early years of this millennium, I invested in a stock that I had really high hopes for. However, this share then promptly fell by about a third. Instead of reassessing my investment case, I held on, hoping to make my money back and perhaps make a profit. Instead, the share price kept falling and I ended up losing about three-quarters of my money when I eventually sold. It was then that I understood this City proverb about selling losers early on: “The first cut is the cheapest”.
4. Buying bombed-out shares
Instead of buying into quality companies at reasonable prices, I would often invest in ailing companies, hoping for a quick rebound in their shares. Today, I realise that ailing is only one letter away from failing. Warren Buffett has compared investing in cheap, unloved stocks to smoking discarded cigar butts. I may get a free puff or two, but this momentary reward can soon become very unpleasant. Why invest in the rest when I can buy the best?
5. Chasing hot stocks and fad investments
During bull markets, it’s easy to get swept along by the madding crowd. As one great quote puts it, “Men…go mad in herds, while they only recover their senses slowly, one by one”. Over the years, I’ve made a few awful investments in hot, fad, and fashionable stocks by running with the herd. Today, I know I am a natural contrarian who prefers to hunt alone. That’s why I stick to buying shares in boring, cheap, and dividend-paying companies!