In the latest episode of Stocks4Docs, we chat about the top nine rules to avoid expensive errors while investing and how to avoid some common mistakes that beginners make.
If you are a value investor, you’ll find that you already follow a lot of these rules based on the principles, methodologies, and teachings behind investing with your values.
These nine rules take away a lot of that guesswork, angst, and unpredictability in investing as much as possible.
Of course, stock investing still comes with risk, no matter how careful you are, but these rules will dramatically decrease the risk.
Without further ado, here are the top 9 rules to follow for avoiding expensive errors with investing:
Rule #1: Take Emotion Out of The Investment.
One of the reasons it’s so hard to be a good investor is because it goes against our natural human psychology in many ways.
We have strong emotions as human beings, such as fear and greed, and these will often drive our actions, thoughts, processes, and how we react to situations.
However, a good value investor tries their best to remove all of these emotions from the equation. They try to stick with their fundamentals, research, and what they know in an effort to take the emotion out of it. It’s challenging because our natural tendencies as human beings are to react with our emotions.
But this is a big mistake that all investors make, especially new investors, so controlling emotions in the stock market is considered a superpower.
Rule #2: Don’t Give in to The Fear of Missing Out.
A big mistake that investors make is buying a stock when it is too high, so when the market is going up, and the price is rising every day for that stock, people start to get a little greedy, especially if they already own some of that stock.
Or, if they are on the side-lines and begin to see an uptake in a price, they will start to think, “Oh, I’ve been sitting out on this stock for so long, and it’s beginning to gain traction, well now that it’s gone up over the week, I’ll buy it because it will continue to go up.”
We rationalize that we don’t want to miss out on this uptrend and feel this fear of missing out.
But, when you’re pouring money into an already overextended market, it’s not a good idea because chances are it’s going to stagnant or fall pretty soon unless there is a reason for the price hike. When often there is no substantial reason.
It’s excellent as value investors because we don’t have to worry about Wall Street’s numbers. After all, we are coming up with our own number and idea of what the company is worth. We are making our own calculations based on facts, values, and financial data of a particular company and then deciding what discount we are willing to buy it for.
That way, it doesn’t matter if a company price is rising on the stock market or if they’ve been sitting out on the side-lines because they already have a pre-set number and are therefore able to ignore the noise.
Don’t buy high! Remember that there are many outstanding companies out there, and try not to give in to the fear of missing out.
Rule #3: Don’t Sell Too Low!
On the other side of the market, when you see a company’s price falling, and it’s been steadily week after week, it can be tough to stay invested in that company.
Picture this: Let’s say someone bought a stock at $300 per share, and it steadily went down from 5%, 10%, 20%, and now they’re down 30%, and they look at their portfolio and think, “I should cut my losses, and sell it.”
But that is fear talking, and it is driving their decision process.
This is the time where the investor has to trust their initial reason for buying that company. Value investors put a lot of thought, time, and effort into choosing a company. So, even if it is going down, the investor must trust their initial reasons for investing in that company and believe that it will recover from the fall.
What a really good investor would do at this point is actually buy MORE of that stock because now the stock is simply on discount. The investor would believe that it is a great company, trust their instincts, and take advantage of the drop because they are confident that it will recover.
This exact situation happens time and time again in history. The most recent being March of 2020, when COVID-19 hit, and the market fell 30% globally. 30% in just about three weeks. But then it turned around and recovered in just one month later.
The people who sold lost all of those gains, but those who actually acted upon that drop and bought further into great companies took advantage of the fall when it recovered just 30 days later.
Moral of the story: Value investors do not give in to fear, yet trust in their initial reasoning and believe in the companies they have hand-picked.
Rule #4: Be Careful of the Short-Term Trading Game.
There are very, very few people who are “good” at short-term investing. Plus, even if someone does well, they end up paying a lot through their taxes.
When someone buys short-term (less than a year) and sells before a year is up, they pay much more taxes on their stock profits. It could be as high as 37% federally because it’s basically your ordinary income tax rate.
On the other hand, if you wait for a year, you could be paying as little as 15% or even less based on your income bracket.
To justify gains and make a lot of money, someone doesn’t just need to do well, but they need to do exceptionally well unless otherwise, they will just be paying their profits in taxes. More importantly, no one can consistently and reliably time the market, so this is very close to the realm of speculation.
Rule #5: Avoid Following the Hot Stocks & Trends.
When a stock is in the news, and there’s a lot of talk about it, there is a massive investment pull.
We saw that earlier this year with GameStop, which was purposely pumped up by an online forum to drive that stock price. They did this to force the short sellers to cover their costs. They moved GameStop up by 400%, and then it fell by 30% right after burning all of the investors in the process.
Be wary of hot trends and stocks because it is indeed another form of gambling. If someone blindly follows the news and buzz without due diligence, they’re partaking in speculation and gambling rather than strategic investing.
Rule #6: Don’t Choose a Company Solely Based on Dividends.
Dividends are tempting because of the payment on a timely basis, and even if the company doesn’t do as well, it’s nice to get some return. But there are some flaws with dividends.
If you look at the S&P 500, they pay about 1.5% dividends. If you find a company that’s paying you 10% or 9%, it’s crucial to stop and think, “why are they paying so much?”
At this point, you should ask yourself if you did your research on the company and love their mission or if you’re picking this stock based on the dividend pay-out.
Remember the four principles that value investors follow when picking a company:
- Circle of competence
- The moat
- The management
- The price
Remember to keep these four principles in mind when buying a stock, rather than just looking at the dividends pay-out because dividends are not guaranteed. The company can always change its mind and cut the dividends, which they can do at any time.
Pro tip: Be careful of high dividends because if they’re driving up their dividends, it is probably because there are many uncertainties in their fundamentals. They’re trying to make it more attractive for investors to consider with the fancy marketing plan.
Rule #7: No One Can Time the Market.
No one can time the market! End of story.
Sure, someone may get lucky a few times, but no one can truly time the market.
But again, as value investors, we don’t have to time the market because we don’t trust gut feelings, yet, we have a solid, calculated, and methodical way to decide when to enter and exit a market.
It’s almost a guarantee that when someone sticks with their guidelines, they will see their money increasing, and it will outweigh any sheer luck that gave some short-term profits.
Rule #8: Reconsider Diversification.
One of the most common pieces of advice heard is to diversify your portfolio when getting into investing.
But that is arguably not a good choice as a value investor.
Value investors want to invest in companies that they are genuinely interested in, ones that they are capable of understanding. This is because if you’re interested in an industry, you will actively want to learn more.
If someone is investing in an industry or company simply to “diversify” their portfolio, they are cheating themselves and adding more work than necessary to their plate.
That will only mean more work and research on behalf of the investor. For example, if someone has zero interest in finance, why should they invest in that industry? Reading about that company will become a chore rather than the exciting experience that it should be.
Rule #9: Don’t Be Afraid of The Risk as a Value Investor.
Fear of risk is the biggest robber of opportunity.
The stock market can be, and is, maybe the most powerful wealth-building tool we have available to us. Use it!
If you, do it correctly and follow a value investor method to minimize risk, you feel good about your decisions.
If I can give you any piece of advice, it’s not to shy away from value investing and to use it as a wealth-building tool that you are proud of.
We hope you all enjoyed this episode of Stocks4Docs and that you hopefully learned something new about things to avoid to minimize expensive errors.
Let us know in the comments if you would add any rules to this list, or if you follow any of these rules diligently. We would love to hear from you.
Looking for more great content about investing, personal finance, and more? Keep tuning into the Stocks4Docs Podcast.