I address this topic because I want you to be aware that the stock market could be a good investment vehicle—investing in it also exposes us to learning disparate businesses. One big advantage of owning stock is liquidity. Unlike investing in fixed assets, you won't be stuck with any stock that falls out of favor. Of course, you have to learn the trade, as well as the tricks of the trade, to do well.
In graduate school under the tutelage of our economics professor, I got pretty good trading on paper. I picked it up again about five years ago using Charles Schwab to keep the cost of transactions low. The market is quite different today, but the fundamentals I learned a long time ago remain true. The market is now dominated by professional traders who are short-term-focused and can cause huge fluctuations in a very short time. I have to get into their mindset to make investment decisions.
The first person I called was Dr. James Holtz, an entrepreneur and long-time investor in the stock market. A student of Charles Townes, he started his career working on laser radar at the Lincoln Lab and laser isotope separation at Lawrence Livermore National Laboratory. Jim was founder/chairman of Star Medical Technologies, which was acquired by Palomar Medical Technologies and then Coherent. I have included the advice that Jim gave me as a sidebar (see "Tips for making good investment decisions") for your reference.
Three tried-and-true principles remain valid:
Preservation of capital is priority one when investing, and making a gain comes second.
A missed opportunity is fine because there is never a shortage of investment opportunities. Avoid being tempted by an opportunity that is too good to be true.
Every stock is fairly priced at any given time.
A free economy is efficient—there is no bargain.
Sell a stock in your portfolio if you are unwilling to buy it at the current price.
These rules enable you to live in the moment to make tough decisions based only on current and relevant information. For example, you wouldn't wait to sell a stock to take advantage of lower long-term capital gains if you have decided to exit the stock.
Then, there are conventional wisdoms like "never catch a falling knife." That is, wait until the market settles before buying a stock. That's wise because some businesses never fully recover until there is a fundamental change in the business. This is especially true for technology companies. And do not get overly excited by new product and technology announcements, even by photonics companies. Stock prices could likely drop when the excitement wears off and investors are faced with the reality that investing in a developing new business is likely to negatively impact earnings.
I only follow about half a dozen companies because I want to spend no more than an hour a day and would invest in no more than three stocks to stay discriminating. Decision-making is kept simple, using mostly data from Yahoo Finance correlated with what else I am able to learn. Decisions are based mostly on revenue and profit growth, modest price-earning ratios within industry norms, and analyst estimates on future earnings and profits. I give a lot of credence to analyst consensus because companies disclose enough to provide guidance just short of violating SEC selective disclosure regulations.
There is no easy way to learn but from making mistakes. First, make paper investments and then allocate only a portion of your assets to the stock market. Invest in quality stock—choose growth companies with a defensible business to avoid volatility. Plan on spending considerable time if you want to take advantage of price fluctuations to shoot for a higher return.
A parting comment is to take all investment advice with a big grain of salt, including mine. Everyone has his or her own risk profiles and investment objectives. Understand the underlying reasoning to formulate your own methodology that is optimized for you.
Tips for making good investment decisions
- Sell until you can sleep at night.
- Don't own a stock that you wouldn't buy.
- If a stock you bought goes down, but the reasons you bought it are now even more true, consider buying more.
- It's OK to make speculative bets—just make sure they are uncorrelated and that they are sufficiently small.
- Don't own too many or too few stocks. Too many is difficult to manage, while too few increases your risk—about 25 is right.
- Invest an amount in a single stock that is right for you. Too much is too risky, but too little isn't worth the effort.
- Have a fair degree of diversity to reduce risk (e.g., international, industry).
- If you have two stocks that you feel equally positive about, but buying one and selling the other is tax-advantageous, do it.
- Take some of your losses on a stock and buy back a month later to capture the tax benefit.
- Don't invest more than 4% of your portfolio in a single stock, no matter how enthusiastic you are about its prospects.
- Always ask yourself, "What makes you think that you know better what this stock is worth than professionals who have more knowledge and have done more analysis?"
- Don't let short-term losses become long-term.
