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Sunday, June 1, 2008

How to lose money and become a better investor

This is the first of a series that I plan to post to help dummies like me become better investors in stocks and mutual funds. If you like reading it, my effort will be rewarded; if you don't, please let me know why so I can improve. I am assuming that you are not as complete a dummy as I was when I first started investing ;)

One of the oft-quoted myths of investments goes like this:

Rule number 1: Do not lose money
Rule number 2: Read rule number 1

Such great advice is totally inappropriate for dummies like me. It is almost like saying "Do not fall down" when learning to ride a bicycle. Just like you will fall down a few times before you learn to ride a cycle, you have to lose some money before you learn to invest in stocks.

In fact, losing money is an essential part of becoming a better investor. Now this goes against the grain of logic. (I will elaborate on this in my next post. I expect that will be next Sunday.)

When you begin making your initial foray into investments, chances are you will not have too much cash in hand. So going to an investment advisor wouldn't make much sense. You will end up going to a relative or a friend - whom you consider to be an expert - and ask for tips or ideas.

Despite best intentions of all concerned, the first couple of investments will probably go sour. Even if the investments actually generate a profit on paper, you may not be able to take that profit home because you will not know when to sell!

If you are a dummy like me, you will enter the market near the top - when all the excitement and buzz is at its peak. Pretty soon the market will drop and you will be left holding your investments - not knowing what to do. If the market drops further, you will get into a panic and call your friend or relative for advice.

Guess what the advice will be? "Hold on a little longer; the market will rise again - sell then." The market will rise but not to the level at which you entered. You will sell at a small loss, relieved that you avoided a bigger one.

A timid investor will run away from the market after such an experience and put the money in a bank - where inflation will eat away a major chunk. A dummy like me will decide to buy some books and learn more about the subject. And he will already be on the road to become a better investor.

(In a future post, I will list out a few books that dummies like me can understand and use.)

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