Misses, writeoffs, bad math and distracted investing can make you poor!
Today, Part 2 of the White Top View series: Playing Market Odds continues. The series covers the ways superior investors play market odds and avoid common investment errors. Links to all parts of the series are at the end of this post.
Last post we discussed the first three of the 6 Sins of new investors: 1. News based investing = bad news! 2. No research and 3. Holding losers. In this post we discuss the next three sins.
4. Buying bankrupt can bankrupt you!
Liquidations are very profitable, for those on the right side of the deals! That is the people in the know and in control. Outsiders need not apply to this inside game.
A business turnaround can rapidly consume shareholders equity. That means buying those shares early is a very high risk move. Far too often some or all shareholder equity goes to zero.
This is an area of business that I know far better than most. I spent much of my career doing turnarounds and liquidations.
Do not be in a rush to buy early. Too many investors buy in early thinking the company has no place to go but up. For company operations that can be correct. But the financial obligations carry on. Costs of the past and financial needs for the future can cut shareholder equity. Even when there is an operating recovery, dilution of existing shareholders can be massive.
Shareholder dilution can water down your holdings
To finance the future, the company often sells shares to raise the necessary capital. This has the effect of dramatically cutting the value of for any existing shareholders. On the other hand, if the company can’t raise capital, the value of all shares is going to zero. All investors then lose as well as employees and the economy.
In very rare circumstances, when it works, results are spectacular. But rarely for common shareholders. Most often those in control make a big score.
Bankrupt is kaput. Especially for new investors, simply avoid the entire headache and costs. Do not buy shares in any bankrupt company as a turnaround play.
5. Averaging down sinks portfolio performance
Investing misses, writeoffs, bad math and distracted investing all combine in the most common of investing sins, averaging down. This really bad but very common strategy can seriously harm your portfolio.
Averaging down means you buy more shares in a loser. Naturally if you keep buying as the price keeps declining, the ever lower costs get, averaged down. This is an awful way to build wealth. It doesn’t work.
The theory is that these new, lower priced shares, when averaged with the higher cost of the shares bought at higher prices, “averages down” your cost per share.
With that new lower cost you have a better chance of making money or at least breaking even because the share price has to rise less to break even. This mathematically correct but bad strategy, puts more money into portfolio losers. But it is really bad math that can dearly cost you.
Superior investors sell losers to buy winners
Instead of selling and moving your capital to a winner, you own even more of a loser. At best, that puts your capital in a coma, even when it does not kill it.
As the average down strategy responds to any big share price drop by buying and not selling, the effect ties up a proportionally larger slice of your portfolio in a dead stock.
The theory goes that with a lower average cost you are closer to break even than if you did nothing but hold your original position. With an averaged down total share cost, the price of the shares has to rises less to recover all your capital.
Owning a bigger piece of a loser is never a good strategy. In fact we want no losers. We want to find and invest in more winners. You get them by selling losers and buying more winners.
One change can increase your returns
Making this one change in your investing approach will dramatically improve your overall performance. If averaging down has been your approach in the past you can easily check my claim on your financial statements.
Just note the amount of your funds tied up in the shares of any loser. Calculate the result of taking those funds into shares of the best performer in your portfolio. Swap any loser shares for more winner shares and watch your portfolio grow!
Not only will that simple change dramatically improve your results, it actually lowers your risk by putting a greater portion of your portfolio in performing holdings. Talk about a simple way to get a big win!
6. No distracted investing, keep eyes on the road to your future
Investing misses, writeoffs, bad math and distracted investing all apply to investors that do not pay attention. Failing to pay attention while investing risks losing your capital!
Not paying attention has financial risks as great as not paying attention while driving! It risks health and property! Not paying attention to your investments significantly risks your wealth. Even with a financial advisor, paying attention pays you big time!
Do all you can to become an informed and knowledgeable investor and client. Avoiding basic investing misses like, writeoffs, wrecks and not watching puts you ahead. The results will show up on your personal bottom-line.
Earn the highest hourly rates of you life, learn to invest
If you give as little as an hour a week to your investments your knowledge and performance can significantly improve. Giving more time will further improve your performance. Learn to invest and earn returns for a lifetime.
Next in Part 3 of the White Top View series, Playing Market Odds, continues discussion of how superior investors watch the economy, market and the specific companies that interest them. All must say yes before the investor risks capital. Links to all seven parts of the series are at the end of this post.
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Have a prosperous day!
These discussions and information intend to help you better understand markets and investing. I am not a financial or investment advisor; opinions are for informational and educational purposes only and are not intended as investment advice. For syndication of the site or blog, please contact info@WhiteTopInvestor.com. © 2014 Bryan Kelly
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Links to all parts of this series follow: