A recent article on CBS MarketWatch extolled the virtues of a “home study” booklet for beginning investors that’s been published for many years by Charles Schwab & Co. (to read the original follow this link: click here)

Called “How to Be Your Own Stockbroker,” this booklet is essentially a set of steps designed to help investors make educated and informed selections of stocks, and to some extent mutual funds as well.

To summarize Schwab’s advice: Read your local newspaper business section; read a national financial newspaper; read magazines and books on the market; take a formal course somewhere, consider subscribing to an advisory service; invest actual money to try out your ideas; take all advice with a grain of salt and make your own decisions.

This certainly sums up the conventional wisdom. But I don’t think it’s what investors really need. Perhaps 20 years ago, investors could give themselves a competitive edge through diligent study of stocks, companies, industries and trends. Knowing more and knowing it sooner once was a prescription for investment success.

But I don’t think that is true any longer. Ironically, there’s so much information available today – and so much computer power to process that information and act on it – that the individual investor simply can’t get a jump on Wall Street.

Yes, it’s worthwhile to read your local business pages if you live where there’s a good daily paper. Of course it’s worthwhile to read a national paper like the Wall Street Journal. All of this falls in the category of keeping yourself informed about how the world works and current events and trends.

I would be the last one to discourage anybody from being informed. But I don’t think Schwab’s suggestions will make you a better investor in any specific way unless you plan to invest in the stocks of local companies. That’s a high-risk approach that’s best left to the experts, as far as I’m concerned.

I discussed this topic with the author of the CBS MarketWatch article, Dr. Paul Farrell, and told him I thought Schwab’s suggestions would do more harm than good by encouraging investors to focus on the wrong things.

Paul then asked me to come up with my own alternative suggestions. The following short list of tips is my response.

Here’s a quick-read summary:

This list isn’t perfect. But if you are a serious investor, these are the five most important things that should occupy your time and attention. If you master these areas, you will be far ahead of most of your competition.

Focus on what you can control.

You can’t control either the weather or the stock market. But you can control your exposure to either one. You can control your asset allocation, the proportions of kinds of assets in which you invest. This in fact is arguably the most important decision any investor makes.

You can control your costs, and you should do everything you can to keep them down. Use no-load funds and shun load funds. Look for funds with low expenses. Index funds are best. Control your exposure to taxes. Use whatever opportunities you have for tax deferred savings such as IRA accounts and 401(k) programs. In taxable accounts, use tax-managed funds such as those offered by Vanguard.

Diversify widely.

Invest in 1,000 companies instead of only 20. This means owning an index fund instead of a “focused” fund that relies on a manager’s stock-picking ability. Peter Lynch, who for a time was one of the best stock pickers of the late 20th century, said, “All the time and effort that people devote to picking the hot hand, the great manager, has in most cases led to no advantage.”

There really aren’t many investing secrets any more. What can be known is already known by so many people that today’s stock prices truly reflect what “everybody knows” about companies.

Imagine that at the start of 2001 you had $5,000 to invest in a big retailer, and your choices were limited to either Wal-Mart and Kmart. Which would you have picked? It’s obvious now and it was obvious then that Wal-Mart is a much more successful company than Kmart. Everybody knows it.

So common sense would lead a savvy person to invest in Wal-Mart and shun Kmart, right? Apparently not. At least for the first half of 2001, the market said the savvy investors were those who bet on Kmart.

At the start of this year, Kmart had a market capitalization (the value of all outstanding shares at the current market price) of $2.5 billion. Wal-Mart’s market cap was $262 billion. By July, Kmart’s market cap had doubled to $5 billion while Wal-Mart’s had shrunk by about 20 percent to $209 billion.

I’m not recommending you be a contrarian investor and bet on underdog stocks. My point is that even with all the knowledge you could have gained from reading about Wal-Mart and Kmart, it’s not likely you would have concluded that Kmart was the stock to buy in January 2001.

Seek great strategies, not good ideas.

Yes, you can get lots of good ideas from books, newspapers, newsletters, magazines and TV shows. But you don’t really need good ideas. They are a dime a dozen. What you need are great strategies.

Good ideas are based on what’s popular now and what will sell. The media write about whatever seems to be in vogue. But did you ever notice how easily today’s best ideas are replaced by another set of ideas, often completely different, next week or next month or next year?

Next time you get a financial publication, go through it and underline or highlight the best ideas you find in there. Then do the same thing with the next issue and see how many of the great ideas in the first issue are repeated in the next one. It might open your eyes to realize those brilliant ideas have been replaced with a whole new set. In the media, great ideas are just a commodity, and there’s an endless supply of them. That’s what sells publications.

Good ideas primarily appeal to the emotions. And emotions primarily lead investors astray. Good ideas might be appropriate for 10 percent of a portfolio that’s otherwise well diversified. But you need something else for the other 90 percent of your portfolio.

What you need is something that will last longer than a day, a week, a month or a year. A great long-term strategy is not emotional. It’s based on facts and research and analysis of your individual needs. It can be refined and fine-tuned, but it won’t need to be replaced in a few years. Unless your own circumstances change, it should be good for years, even decades.

Know yourself.

You would be amazed at how few investors can tell you what their specific objectives are and the rate of return they need in order to achieve those objectives. Fewer still can convincingly describe the amount of investment risk they are willing and able to accept.

It’s pretty easy to know which stock pickers are the current darlings of the media. But that knowledge doesn’t help you in any real way.

If you know yourself, on the other hand, you will be a better investor.

Knowing yourself requires some hard work. You have to think about inflation, about your priorities, about time periods in your life. You have to make choices and commitments. You have to gather information on the assets, income and expenses you have now and those you expect to have in the future.

You have to know what you want from your investments, whether it’s income, growth or capital preservation. In order to know what rate of return you need, you must know where you’re going and how soon you want or need to be there. A financial professional can help you with this process, but you still have to make the choices. Otherwise, you can wind up with somebody else’s preconceived ideas about your life and your future.

Take action.

All the knowledge and understanding in the world are no good to you unless you do something. Investing requires making a commitment into the future, then turning that commitment into action. Often, this is uncomfortable. But if successful investing was comfortable and easy, everybody would do it.

I’d like to make this point by quoting from an excellent article that Ed Ward, a registered investment advisor on our staff, wrote exclusively for our clients. His article was titled “Investing is war!”

“General George Patton’s terse advice to GIs in World War II might be useful to investors today: ‘Move!’ Investors can either advance or retreat. In war or the market, if you keep retreating, you will lose. And if everybody else is retreating, it’s often time to advance.

“Over long periods, the stock market outperforms all other financial assets. Yet many long-term investors fail to get the benefits. Why? More than 90 percent of investments by individuals are made near market highs. And the majority of sales take place after investors have lost more than 10 percent.

“Right now many investors feel like retreating to cash while they wait until the future is clearer. That’s understandable, but unwise. By the time most investors become convinced that a bull market is happening, most of the move has passed.

“If you want the high returns of equities, you’ve got to be in the market, not on the sidelines. Inaction leads to the very result investors want to avoid: poor returns. When the market moves, it waits for no one.

“If Patton were advising investors today, he might say: ‘Your enemies are fear, greed, impatience and procrastination when you know you must do something. Your allies are patience, discipline and a sound strategy.’

“The best strategy for you must start with a portfolio that protects you from devastating losses. Yet at the same time, you won’t end up a winner unless you can weather the inevitable setbacks of the market.

“General Patton could have said all this more concisely: ‘First, protect yourself. Then seize the moment!’ ”

 

 

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