Hindsight: Helpful Rules for Investing

HINDSIGHT: HELPFUL RULES FOR INVESTING

by Taylor Moffitt of Halydean

A common quote of money managers in the financial markets is that “hindsight is worthless.” Anyone who has been investing for any worthwhile period of time will inevitably accumulate several regretful investment decisions. Among those, a few have yielded some insights that may be worth repeating. Some of these insights from hindsight may have worth to the readers.

No penny stocks. Never buy penny stocks. Looking for a good investment among penny stocks is like looking for a good wife in the red light district: It is possible, but the odds are unfavorable. Penny stocks are loaded with companies that are poorly funded and not good at reporting their financial positions. The worst is this: If the company the investor buys is targeted by the SEC for fraud et cetera, the investor can be dragged into the mire as well. Avoid penny stocks and all stocks on the OTC Markets at all costs.

No day trading. Study after study has shown that day traders are statistically at a disadvantage. It is statistically akin to investing at a casino table. The more the day trader trades, the higher the probability that the trader will lose money. There is no research in the academic literature that indicates that any day trading practices can be consistently possible.

No emotion. Emotional investing has no rationality, and can only cloud judgement. Investment decisions should be made based upon quantifiable data alone. Fear and excitement are highly correlated to irrationality.

No faith investments. God should not be reduced to being a fortune teller for personal gain. Fortune tellers are fake. “Stepping out in faith” when it comes to an investment is not spirituality. It is naive. While there are many examples of individuals getting very rich in the Bible, there are no examples of God giving anyone investment advice. In the Bible, wealth is either attributed to luck (Ecclesiastes), the natural side effect of wisdom in action (Proverbs), or the favor of God that happens without explanation (Job). Investing in a company because they are “eco friendly” or because they are “Christian” or because they are “Culturally enlightened” is akin to selecting your heart surgeon based upon their religion or good recycling habits.

No black boxes. No investor should ever invest in something that he or she does not understand. If the words “trading platform” is used to describe the mysterious manner of how the rich keep getting richer, the investor should run the other way. This rule may throw out a few proverbial babies with the bath water, but in a market filled with tens of thousands of investment opportunities, it is statistically advantageous to just avoid the whole mess of things one does not understand.

No time bombs. Investments that have approaching expiration dates should be avoided at all costs. While it is possible to prove that some investment positions have a statistical advantage and high fundamental probability of price appreciation, no investor can predict the time frame. Sometimes investments take longer than expected. One should expect delays, and then one will never be disappointed.

No overweighting. A diversified portfolio is wise. No one investment position should ever be more than 10% of a portfolio, and only under the rarest instances should an investment position be more than 5% of a portfolio. If a position grows to be overweighted, that is good news, but investors should no go out of their way to add any new position to their portfolio by adding too much weight to it. This is abandoning the diversification plan. Proper weighting should include industries too. For example, a bank that had 10,000 different mortgage positions in 2008, but was all invested in residential housing, was still precariously overweighted and at risk. Proper diversification also includes: diversifying into various industries that may complement each other, diversifying into various nations and economies that may diversely complement each other, diversifying into various opposing currencies, and diversifying into various types of different industries. If a portfolio has 30% of its positions in industrial manufacturing companies, even with thousands of different stocks, the portfolio is overweighted. Startups should never be overweighted in a portfolio either.

Remember cash flow. Investors should work, and maintain their financial security in terms of cash flow. This may mean not quitting one’s “day job” until one has enough cash flow from investments. Many investors lose sight of the difference between gains in net worth versus gains in cash flow. Investment positions that provide cash flow must be included in any portfolio that has balanced diversification.

No pioneering. Investors should follow experts. Floyd Butterfield is the man who invented the modern ethanol manufacturing industry as we know it today. His model of the “24/7” operational distillation using a boiler and multiple fermentation tanks is used today the world over. Floyd Butterfield once personally told the author, “The pioneers get shot with arrows, but the settlers take the land.” Pioneering investments are statistically very risky. The garbage can of Wall Street is littered with better mouse traps and pioneers who innovated wonderful new things. Pioneering is for venture capital investors who have their own rules of investing. Leave pioneer investing to the venture capitalists.

No industry overturns. If a new company’s success will mean the death of an entire industry, do not expect that industry to go down without a fight. Sometimes even fantastic companies can become “road kill” as larger, more established companies systematically destroy them because they are viewed as a threat.

Expect inflation. Any study of history shows that democracy tends to vote in favor of lower taxes and/or more government spending. The political solution to this problem is always for the government to go into debt. The current governments driving our global economy are all shining examples of this principle in action. Even a cursory analysis of http://www.usdebtclock.org shows that in order for such massive debts to be serviced, the government will be forced to expand the monetary supply (create inflation). This means that investing in a 30 year bond yielding 3% interest is as naive as it is optimistic. Owning an “I owe you” from any government these days is perhaps a “faith investment” (see above). A better move would be to invest in businesses and industries that can profit from inflation.