My Real World Rules for Investing

I've seen all sorts of articles and books about how to invest. They are mostly mainstream thinking with a lot to offer on the basics. Few though have given a realistic view of investing that comes from years (decades) of experience.

My honest assessment: Investing can drive you crazy. My 30 years of experience in the business has shown me that, despite what you might have heard in the media, investing is not easy. My eight tongue-in-cheek investing rules below are bound to make things difficult and complicate any strategy. But if you create a smart, long-term plan and stick to it, you increase your odds of success.

None of the following has been scientifically tested or can be supported with documented data. It is all from my personal experience and what I've seen investors do. But if you have been investing for more than a few years, you will smile and say to yourself, "Yup, that happened to me!"

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Rule #1: Stocks go down after you buy them and up after you sell them.

Example one: You've been watching XYZ stock climb for two weeks. You do your research. You decide it is a good buy and purchase 100 shares. It immediately drops a point on bad news, or the market itself turns down for no reason at all.

Example two: You've held onto XYZ for two years and have a nice profit. The consensus reports say the stock is above its target price, analyst ratings are being reduced and earnings estimates are dropping. It looks like XYZ is running out of gas. To protect the tidy profit you have, you sell. Of course, within days of your selling, the stock jumps five points, and you wish you had waited.

If it hasn't happened to you, you are either the luckiest investor ever, or you have never invested in stocks.

Rule #2: Your friends are NOT doing as well as they say.

When it comes to talking about your investment portfolio, who wants to tell their friends about their lousy trades? Nobody. So your friends are going to tell you they bought Microsoft before it went public. But they are not going to tell you they bought Crocs (remember the world's ugliest shoes?) at the top and rode it down to the bottom.

Rule #3: Waiting is always a mistake (except in the case of Rule #4).

Example: You've decided to buy XYZ stock. It's trading between $44.50 and $45. You wait to see if it drops to $44 to buy it. You turn away from the screen for a minute and when you look back, it is now $46. Rats!

On the other hand, you want to sell ABC. It's trading between $21.50 and $21.75. You want to get $22. You decide to wait until after lunch to see if it has gone up. Too late; it dropped to $19. Everybody else sold it at lunch!

Moral of the story: Once you've made up your mind, just do it.

Rule #4: Always wait (except in the case of Rule #3).

Acting on instinct is for animals in the wild. Investing is based on research and information. A buddy tells you about XYZ Corp. It's a great buy he says. You buy before checking it out. The next day, company management announces earnings that come in below expectations. The stock gets crushed.

On the other hand, you have a stock that has gone nowhere for years. It's getting boring. You decide to sell before checking the current research. The day after you sell, the company announces a takeover, speculation of which had been written about in several research reports.

Moral of the story: Don't act on instinct, and do your homework first.

(Yes, rules #3 and #4 are contradictory. From what I've seen personally, here's how they work together: If you wait to buy, the stock goes up before you buy. If you buy right away, the stock goes down after you buy. See Rule #1.)

Rule #5: Never buy a hot stock.

A hot stock is one that everybody is talking about, goes up zillions of points at a time and has little to no fundamentals. It is gambling. I cannot count how many hot stocks I've seen over the past 30 years that went straight to the moon and then fell back to earth.

Remember, a stock's price is not always reflective of the company's worth. It is the collective wisdom of buyers and sellers. Maybe they are right, maybe they are wrong and maybe they are crazy. The crowd that is buying XYZ may not know everything there is to know about XYZ Corp.

Rule #6: A falling stock price alone does not make a good buy.

Many investors fancy themselves the next great corporate raider. Whenever a big name drops, they want to swoop in and buy. Unfortunately, when a big-name company has a big drop in price, it is usually for a good reason, and many times, only the beginning.

Remember Pan Am? Enron? AIG? Worldcom? Sears? All big names, all tops in their industries—and all had major falls. Buying any of these on their dips would have been a disaster.

Rule #7: You are not smarter than the market.

No matter how insightful you are, how much research you do or how lucky you are, you cannot know everything, and Mr. Market loves to prove it. That is why Rule #8 is so important.

Rule # 8: Do your homework.

If you are doing your own investing, then you need to know your securities inside and out—know their competitors, sectors, fundamentals and technicals, risks, how much they could drop and how to mitigate it. Have a strategy for every scenario.

If you use a money manager, what is the strategy you laid out together? Does the risk being taken match your own risk tolerance?

Bottom line: The rules above were mostly tongue-in-cheek, but they have some truth behind them—and they prove that investing is not easy. Investors that look too short-term likely will be very frustrated and end up switching from strategy to strategy. Investors with a longer-term outlook likely will have a much better investment experience and success.

John Riley, registered Research Analyst and the Chief Investment Strategist at CIS, has been defending his clients from the surprises Wall Street misses since 1999.

Disclosure: Third party posts do not reflect the views of Cantella & Co Inc. or Cornerstone Investment Services, LLC. Any links to third party sites are believed to be reliable but have not been independently reviewed by Cantella & Co. Inc or Cornerstone Investment Services, LLC. Securities offered through Cantella & Co., Inc., Member FINRA/SIPC. Advisory Services offered through Cornerstone Investment Services, LLC's RIA. Please refer to my website for states in which I am registered.