At one point or another, even the most seasoned and experienced investors have made bad investment decisions…
I’ve certainly made my share… like selling too early more than once.
Even Daily editor Teeka Tiwari… a man who’s arguably helped more readers become millionaires than any other newsletter editor we know… has made his share of bad investment decisions.
By late 1998, I’d lost it all… Instead of taking small bets on high-risk, high-reward ideas, I was taking massive stakes…
I’d built up a substantial portfolio. But I stuck around too long and got too greedy.
And when the market went against me, I made bigger and riskier bets. I lost all perspective and was investing for my ego, not my bank account.
Within three weeks, I lost everything I’d made and more. I went from wealthy to poor in less than a month. And ultimately, I was compelled to file for personal bankruptcy.
Whether you heard about a hot stock or crypto, and “bought the top” before a big plunge… or you held on to a big gain too long and watched your profits wither away… fear likely played a role in your decision.
You see, the emotional roller coaster ride shakes many investors out of the market. They buy at tops and sell at bottoms…
This is the main reason the average investor severely underperforms the market. They have incredibly bad timing.
In fact, a recent study shows that profiting from the market is less about what you buy and more about when you buy and how long you hold.
So Easy a Baby Could Do It
The study – called “Selling Fast and Buying Slow” and authored by professors from the University of Chicago and MIT – analyzed the historical performance of 783 portfolios owned by both wealthy and institutional investors (like pension and hedge funds).
To judge the performance of these Wall Street elites, the study compared their results to a portfolio of alternatives randomly selected by a baby.
So no investment knowledge or even the ability to read was needed… just a baby randomly pointing at a screen…
And the results were pretty revealing.
When it came to buying stocks, the pros outperformed the babies by about 1.2 percentage points.
Now, that may seem like a small number… But when you factor in the power of compounding, that 1.2 percentage point difference leads to massive outperformance over the years.
But when it came to selling stocks – and actually booking profits or losses – it was a completely different story.
The babies’ random selections outperformed the Wall Street elites by 0.8 percentage points.
(And since Wall Street greatly outperforms Main Street… the babies would likely outperform the average investor, too.)
Now, we’re not saying that all your investment decisions should be completely random… but the takeaway here is pretty clear.
While analysis and research definitely lead to better buying decisions… Removing emotion and bias from your selling decisions leads to better results.
Unfortunately, human nature means that emotion often overrides even our most rational decisions… and when the market is volatile and prices are falling, stepping back and thinking rationally can be the hardest thing to do.
That’s why we put together some rules to help you become a more rational investor… and protect your portfolio whether the markets are up or down.
Three Rules for Rational Investing
Whether you’re eying a new investment or unsure about cashing out your gains, these three rules will help you make more rational investing decisions…
- Diversify your assets.
The secret to building wealth – and keeping it – is diversification. That’s why we publish an asset allocation guide each January. It’s our most important issue of the year. (Palm Beach Letter subscribers can read our 2021 guide here.)
We recommend a mix of stocks, bonds, cash, real estate, collectibles, cryptos, and other alternatives.
Not only does diversification lead to better returns, it also lowers risk. Numerous studies show that asset allocation accounts for 90%-plus of your investment returns.
Diversification also means your losses are less painful since they’re offset by your winners… so you’ll be less likely to give in to fear and sell at the wrong time.
- Tune out short-term forecasts.
The market’s short-term direction is unknowable. No one has a crystal ball. Even experts get it wrong more often than right.
Whether it’s stocks or crypto, unless you’re a day trader, daily volatility shouldn’t bother you. So don’t get sidetracked by the noise. Just focus on the big picture.
If the long-term fundamentals that led you to buy are still intact, then you don’t need to be afraid of temporary price dips or bumps in the road.
- Have a risk management plan.
Before you can grow your wealth, you need to protect the wealth you have. The best way to do that is with position sizing. Adding a stop-loss policy can help, too.
Position sizing refers to the size of a position within your portfolio (or the maximum dollar amount you’re going to trade). Our simple rule of thumb is: If an investment gets stopped out of your portfolio, your maximum loss should be no more than 2.5–5% of your portfolio’s value.
If you know your downside is capped, then you can sleep well at night. This way, you won’t panic-sell at the worst time.
Babies, Buffett, and You…
If a baby pointing at random stocks to sell can outperform even the most skilled Wall Street advisors, then the right investment mindset can definitely help you do the same.
And remember, you don’t always have to sell an entire position… Legendary buy-and-hold investor Warren Buffett says his favorite holding period is “forever.”
For your core positions, like broad-based equity index funds, a buy-and-hold approach should work just fine.
And by following these three simple rules, you won’t let fear shake you out of the market at the wrong time… while you ride your winning investments to the top.
Analyst, Palm Beach Daily
P.S. Once you’ve got a solid portfolio game plan, it’s just a matter of finding the next big investment to ride to the top. And one of the biggest opportunities we see today is in crypto and blockchain projects…
As $4 million flows into crypto every week, these underlying blockchain projects will trigger a massive shift of capital into the sector as our financial systems evolve.
In fact, Teeka’s already invested hundreds of thousands of dollars from his own personal bank account… into what he believes will become one of the biggest investments of 2021.
To learn more about this major shift and how you can reap its rewards, click here.