Lesson 1 – Investment Advisors are Salespeople

When I started out with my very first investment, I was “recommended” a mutual fund with an 8.5% front-end load.  For those who aren’t familiar with a load, this meant that for every $100 I invested, only $91.50 made it into my account.  The other $8.50 went for sales commissions and to the fund company.  On top of this, the fund that was “selected” for me had a poor long term track record, high volatility and very high annual fees.

I was pretty naive at the time and I didn’t realize that there were some great no-load mutual funds, where my entire $100 contribution could go into my account.  And, they had good long-term track records and low annual fees.  Of course, my friend and “Advisor” would never tell me about these no-load funds, because they didn’t pay any commissions.

Lesson 2 – No-Load may mean Hidden-Load

It didn’t take investors long to catch on to such obvious skimming of their contributions and soon even novice investors began to demand no-load mutual funds.  The financial services industry quickly responded with new “Advisor Class” funds, that had no front end load.  Instead, they have much higher annual fees and a “Redemption Fee”.  So, the longer you stay in these funds the more of a “load” you pay.  And, if you try to leave the fund you have to pay to get out.

So, although the fund is technically “No-Load”, the Advisor is assured of a commission, the fund company collects higher fees and you get to pay for all of this.  An extra percent per year may not sound like much, but it definitely adds up over time.

Lesson 3 – Commissions can Affect your Investments

Another thing I realized very early on, is that most of the Financial Services industry works based on a huge conflict-of-interest.  Often, Advisors are paid the highest commissions for selling clients the riskiest or worst yielding investments.  From whole life insurance, to limited partnerships and variable annuities, some investments pay much bigger commissions to your Advisor than others.  And, you can bet your assets, that it’s not in your best interests to buy these investments.

Another huge commission-based issue is the subject of churn.  Your Advisor usually gets a paid a commission every time you move your assets into a new investment.  The more your investments get moved, the more your Advisor gets paid and the less your investments are likely to yield.  A good investment advisor would never churn their client’s accounts.  But, it definitely happens.

Lesson 4 – Investment Advice is Rarely Objective

Back in the stone ages, when I started investing, the Internet wasn’t around for investors.  There weren’t any blogs and statistics weren’t available with the click of a mouse.  Back then, it was hard to get good investment advice.  You either had to buy an expensive newsletter or you had to buy one of the financial magazines or newspapers.  And, the recommendations of these financial papers closely mirrored the products of their advertisers.  Biased advice can cost you a lot.

Another thing that happens frequently, is that investors get a “hot tip” about a hot stock from their investment advisor.  But, when they purchase this stock, it turns out to be a real dog with poor fundamentals.  The reason this lousy stock was recommended to you, is because it is underwritten by the brokerage.  Advisors push these stock and analysts give them good reviews, because the brokerage makes a lot of money on the underwriting fees.

Lesson 5 – Taxes and Inflation are Part of the Equation

When calculating your investment returns, don’t forget to subtract taxes and inflation.  Investment decisions are never accurate without taking these into account.  A 12% return is closer to 4% after taxes and inflation.  And, you are probably losing money on anything yielding less than 7%.  I base these calculations on 5% inflation and 25% taxes.  And, this doesn’t include currency fluctuations.

Feel free to disagree with me.  Feel free to  plug in your own numbers.  But, make sure that you take this into account or you may be over-estimating the returns from your investments.  More importantly, you may be under-estimating the risk involved, for the return you receive.

Lesson 6 – The Market Moves in Cycles

One of the most obvious ways to profit from the stock market is from the cycles that occur regularly.  The market goes up and down with the economy.  Also, money moves between large cap and small cap stocks and between growth and value positions, as they change in popularity.  Even some types of stocks are considered cyclical.

The first lesson of market cycles is that it’s very difficult to time the market.  I still own a home-builder stock that I held onto just a little too long.  So, I don’t have any great advice, except don’t fight the trend.  If the market is moving solidly in one direction, going with it is usually more profitable then going against it.  And, if it has been moving in one direction for a long time, the cycle may be nearing an end.  So, take some of the profits before the direction changes.

Lesson 7 – I’m Not Smarter than the Market

Recently, I have thought a lot about the failure of Long-Term Capital Management.  In case you aren’t familiar with the story, LTCM was a huge hedge fund that failed in 1999.  Some of the most brilliant minds in the industry, including two Nobel Prize winning economists, lost billions of dollars and were forced to liquidate the fund.  They created a financial model that supposedly would require a six-sigma event to fail.  Well, they were wrong and it failed spectacularly.

On a number of occasions, I have been reminded by the market that I am not smarter than it.  In fact, the Market delights in making people look stupid.  The reason no one consistently outperforms the market, is because the market quickly adjusts to any profitable strategy.  So, take advantage of market trends and don’t try to beat the market.  You may succeed at market timing for a short time.  But, sooner or later, you may fail in spectacular fashion.

Lesson 8 – Diversification is More than Stocks and Bonds

Having been through Black Monday and the Tech Crash, I strongly recommend having some real assets, such as real estate and precious metals.  Real assets hedge against inflation and protect you from stock market panics.   I also recommend some International exposure, such as global or international mutual funds.  International holdings help to insulate you from the local economy and currency fluctuations.

Obviously, these types of investments pose some risks and may require some expertise.  But, they will diversify your risks more broadly.  If you are a novice investor or don’t have a lot of capital, you may want to consider mutual funds, REITS and ETFs that will allow you to invest in these asset classes.

Lesson 9 – Look for Value in your Investments

There are many strategies for finding investments.  One of the most consistent strategies over the long haul is to look for investments that trade at a discount to their book value.  This is commonly known as Value investing and it makes a lot of sense.  Just as you should look for value in any of the products and services you buy, you should also look for value in the companies you invest in.

The first lesson of Value investing is that some stocks are cheap for a reason.  That’s why it’s called Value investing and not Cheap Stocks.  The stocks of dying companies are almost always cheap, but they are never a bargain.  Other investors can predict the future of these companies and avoid their stocks.  That’s why they are cheap.  The real secret of Value investing is in selecting good companies that are a good value.  This brings us to the final lesson.

Lesson 10 – Buy Companies, not Stocks

Some of the greatest investors Wall Street has ever seen, became successful with this simple premise; “You aren’t buying a stock or a security, you are buying part of a company”.  Too many investors (including myself) make the mistake of following the stock prices, without understanding the fundamental value of the company.  The value of the company is hard to calculate.  If it is a market leader, with good products and management, it may become very valuable.

If a company is poorly run or it’s products can’t be sold, it makes no difference how the underlying security is valued.  You will lose money on this stock sooner or later.  This is a big lesson I learned from the dotcom era, where earnings didn’t seem to matter.  Trust me, earnings do matter.  And, so do the products and the management.  They matter more than the current value of the stock.

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