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I don't know much about investing, but I recently had a chance to interview Reto Gallati, author of Investment Discipline: Making Errors is OK, Repeating Errors is Not OK, to get his input on investing.
1) What are some common mistakes investors make when they don't show discipline?
Investors rush into a decision without fully understanding what they do. They don’t spend enough time on research trying to understand what the investment actually is. Many investors don’t spend enough time on research. They buy positions that look great on a website or in an investment letter, but it does not fit into the investors portfolio because it doesn’t match their investment objectives, the time horizon etc. Another common error is to hold on to position too long. Rather than selling a position when it reached a certain profit or limit the loss when it exceeds a certain loss. In the end such an investor is ending up with collecting “losers”.
2) One of your rules is "become a contrarian." Can you expand on that a little bit?
We are living in a fast-paced world. Headlines over headlines run across the tv screen, newspapers bring daily snapshots of what you are supposed to buy. We are tempted to follow such leads and effectively become short-term oriented traders. However, such recommendations generate a behavior, which I call “chasing success”, which is very difficult. Only a tiny fraction of the market participants is effectively able to predict the right investment at the current moment and make a lot of money.
You can be conservative and long-term oriented by behaving contrarian and for example establish low cost basis in gold when gold is out of favor and Treasury bills are cheap. Gold exceeded $1,000 in mid-March 2008 when the economic outlook was dismal and gloomy. Establishing a position at $450 in Q2 2005 would have generated a net return of 257%. As a contrarian you make decision that are not synced up at the moment (short-term) with the general market. What is needed to do so is, the willingness to accept a long time-horizon, establish low-cost investment by doing serious research and the nerves to accept temporary setback. As a consequence your portfolio is no longer dependent on short-term events and becomes more shock-resistant. A good example is for this approach is Warren Buffet or Peter Lynch.
3) What are a few ways investors can overcome common mistakes?
Write down what you want to achieve (objectives) and compare your effective portfolio with your objectives. You will see that over time you loose the focus and start buying/selling position you actually don’t want to have.
Establish a target price for each position when you buy the securities. By establishing a target price you will do the research, monitor your positions regularly and you will not be surprise either on the up- or downside. You keep the oversight over your holdings.
Always invest with a margin of safety. Whatever you do, assume a safety margin by buying positions through limits.Define your target price when you are willing to sell, but don’t be too greedy. You can always reset the target limit higher if your investment fundamentally improves. When you go into an economic uncertainty only go for high quality investments and don’t buy a company just because the price dropped a lot.
3) How can investors "get their feet wet" if they have no experience with investing?
Establish a paper-portfolio on a website like cnnfn.com and monitor the success of your positions as if they are real.
Start with mutual funds and etf’s first. These financial instruments have a diversification in itself and will help reducing the risk. Don’t buy leveraged instruments at the beginning, they are volatile.
Do you have a special knowledge, which might help you collecting experience faster? Some novice investors actually work in an industry where they have good insight what is happening. Or they have a family business in a specific industry and therefore already know certain things that happen in this industry.
Once you established a certain comfort you might want to do research on individual companies or themes in the same investment universe as some of your mutual funds and etf’s. Always compare research from different sources!
Increase stepwise the complexity of what you do, starting with smaller amounts and well diversified.
Talk to your parents, friends etc. how they do it and what was good and negative for them.
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