Here at Welcome to the Nerdery, we do things a little differently, like make money based on Logic, Market history and what has actually worked in the Market. I know what I’m about to say is going to ruffle some feathers and go against conventional wisdom but there is a reason most people do not make money in the Stock Market.
First and foremost: Do not buy Penny stocks! I cannot say this any more clearly. I could use some four letter words to urge you to not buy these things but I’ll keep it clean. Penny stocks are priced the way they are for a reason, they are crap and not worth anyone’s attention much less your hard earned money.
Unlike most things we purchase in life, buying stocks is not an exercise in “let’s make a deal”. In the Stock Market, you get what you pay for. Historically, Penny Stocks have been a hotbed for fraud and believe me; I’ve seen it first hand, for Stock manipulation. Too many people want to get rich quick and Penny Stocks look like a huge opportunity to buy a lot of shares and if it only goes up by XX%, I’ll make a killing. You may get lucky but trust me, you are going to lose and lose big time.
Pro Tip: Did you know that 70+% of all shares purchased in the market are due to Institutions? Institutions like, Mutual Funds, Banks, Hedge Funds, Pension Funds, etc.
These Institutions invest Billions and Billions of dollars and need to buy 100’s of thousands of shares that Penny Stocks just cannot provide. Even if the Institutions could buy into them and not drive the price sky high, there is no way that a Fund could ever sell out of it at a profit before driving the price straight down again. So they stay out and besides they wouldn’t invest in them anyway as they do not have a track record of Corporate profitability or they wouldn’t be priced that low anyway. Not to sound like a broken record, however, since the Big Institutions stay out of these thinly traded stocks, it leaves a vacuum for manipulation and fraud. If the Big Boys stay out, so should you.
Secondly, the strategy of Diversification. This one is going to get some pushback. Diversification is probably the most misused and misunderstood strategy in the investment world today. Diversification is the process of spreading your money out over many different types of investments.
This concept is widely promoted and preached as gospel. It makes perfect sense at first glance but let’s look a little deeper. Most Advisors/Brokers and anyone else you talk to that invests will tell you to diversify. How many millionaires do you know that invest and are spread all over the place financially? Yeah, I don’t know too many and the truth is, the ones that I do know do not diversify or spread their money all over the place. As Bill O’Neil says “Diversification is a hedge against ignorance”. If you do not understand what to invest in or how the market works or understand market history, then you spread your money all over the place and hope something will go up. The problem is the other investments you’ve allocated will lag or go down while some go up. Yes this will take some of the bumps out and your money and your overall investments will be less volatile, however, you get watered down returns, at best.
You might say, “Chad, I own a mutual fund and it has 100 companies in it, isn’t that diversification”? Yes, owning a mutual fund is the right type of Diversification. If one or even a few of those companies go bankrupt or drop in price significantly, the others should help keep the overall value of the fund up. What I’m concerned about is owning a Fixed Income fund, a Growth Fund, A Real Estate Fund, a Bond Fund and some other type of Fund. This is only watering down your returns and for what purpose, to make you feel safe?
I’ll take it a step further, if you own individual stocks, I can make the case that you should only own at most 6-8 stocks at any given time. There is no way you can keep track of more stocks than this at any given time. Put your eggs in a few well-selected baskets and watch it like a hawk. When it’s time to sell or you find another stock you want to buy, sell the one with the lowest return or better yet, the one showing a loss. This brings me to controversy number two and the third mistake most investors make.
Lastly, Averaging down. Ugh, I can barely type this let alone advise anyone ever do this.
Pro Tip: Averaging down on Mutual Funds is ok, NEVER with individual stocks!
From time to time, buying a stock at a lower price than when you originally purchased it will help lower your cost and the stock will probably rebound and move higher, however, when the market goes into a correction or worse, a Bear market, all bets are off and you may never see the stock recover again, like ever. World Com, Enron, Lehman Brothers, Lucent, Yahoo, Valeant, the list is so long I could write for days about stocks that have never come back.
Don’t tell me you’re a long term investor because your stock is down and you didn’t get out in time, this is money that is wasting away in a company that isn’t going anywhere. This is money that could have been preserved and working for you somewhere else. Remember this, all stocks are bad until they go up.
Pro Tip: NEVER invest more money in a stock that goes down, if you were wrong the first time why compound the situation by throwing good money after bad?
As for Averaging down in Mutual Funds, well that’s a different story. As I mentioned before, a mutual fund is made up of 100’s of stocks and yes a few will be duds but the balance of these companies will recover when the market recovers and moves higher. Averaging down or Dollar Cost Averaging is one of the greatest strategies you can employ with a well selected mutual fund. Buy more shares at a lower price and now you own more shares at a lower price and when the market recovers, more than likely so will your mutual fund due to most the stocks that make it up, will recover as well.
Averaging down on an individual stock is Russian roulette. The stock may not go to zero but it may be years if ever that it recovers to the heights at which you purchased it.
Until next week hit me up with any questions or topics you’d like to cover in the future,
Welcome to the Nerdery,