There are common myths about investing that can often scare off the individual investor and make them wonder if investing is worth it. Here are 3 common investing myths and their realities with Rule #1 methods, so you can grow your wealth and reach your financial goals.
Myth #1: You Have to be an Expert to Manage Money
One of the biggest myths about investing is that it’s hard and should be left to the experts.
You don’t have to be an expert, you just have to be an expert in one small part of the market. We call it being an inch wide and a mile deep. You simply pick a part of the market you’re already interested in by virtue of your hobbies, passions, expertise, work, and shopping preferences.
I might love motorcycles, rebuild them for fun and profit, and thus know quite a lot about companies like Harley Davidson. That intimacy with a product can easily be extended into similar products like 4-wheelers and snowmobiles.
A little knowledge about why I like Chipotle Grill better than McDonalds can, with a bit of reading, give me an expertise in fast food companies like McDonalds, Burger King, Jack In The Box, Sonic, and many more.
Once I get a mile deep in my chosen area, I’ll be able to put a reasonable value on many of the companies in that industry. Then it’s just a matter of waiting patiently until the normal market fluctuations bring me a great company at an attractive price.
You have to be patient.
Even Warren Buffett doesn’t pretend to be an expert in the whole market. His partner, Charlie Munger, said that he and Warren have an edge over most professional fund managers because they know what they know and they stick to it. Almost no other professionals do that.
For example, Warren’s portfolio is mostly invested in just a few companies.
Just focus on what you know, stick to it religiously, and wait for Mr. Market to drop the price.
Myth #2: You Can’t Beat the Market
While it is true that the guys who run your mutual fund or pension fund do not beat the market (96% fail to do so over 5-10 years), little guys armed with basic knowledge of how to value a business can and do smash the market. Some of our Rule #1 students are reporting compounded annual returns over the last 5 years of as much as 47% per year just doing solid long-term investing.
The reason for the discrepancy is size. The Big Guys run big funds and the total dollars makes them quite illiquid. That means it’s hard to get in at one price and impossible to get out at one price.
In fact, the act of a Big Guy exiting a stock is the reason the stock price goes down and the price drop is what causes other illiquid Big Guys to panic and sell and that drops the price even faster. It takes a Big Guy investor something like 8 to 12 weeks to exit a position. This fact is what creates so much emotion in the market and is at the root of why good companies are sometimes on sale; some relatively short-term problem creates panic selling among fund managers and the price drops far below the value.
If you can stay unemotional and you’re knowledgeable about that company and industry, you can buy it at a great price when the Big Guys are in full panic mode. And when you do that, you will crush the market.
Myth #3: The Best Way to Minimize Risk is to Diversify Investments and Hold for the Long Term
This is really good advice for people who are ignorant about investing basics. If you don’t know what a business is worth, you must diversify to protect yourself from your own ignorance. But the truth about real investing is quite different; almost no great investors diversify.
Warren Buffett’s portfolio of over $100 billion is focused on about 10 stocks. Mohnish Pabrai, a hedge fund Rule #1 type guy with a 28% compounded annual return for 12 years and Eddie Lampert at ESL, another Ruler, own less than 10 companies right now.
As Buffett said, diversification is for the ignorant. The right way to invest is to get an inch wide, mile deep, stick to it, and own maybe 5 to 10 great companies.
Risk doesn’t come from not being diversified, it comes from not knowing the value of that business.
The idea of holding long term is a good one, but when things change, the investment has to change too. Holding a bad company long term is a recipe for a disaster and it will convince any ignorant investor that diversification is the answer to the problem.
But the real answer is to only invest in what you understand and only when it’s on sale. If you do that, essentially you’re buying $10 bills for $5. If you can do that, diversification is a waste of time and likely to lower your returns.
The bottom line is, find a great business that you know and that is on sale, and learn how to invest with Rule #1. If you want to learn more about Rule #1, the same style of investing that Warren Buffett uses, click the button below to get my quick start guide to Rule #1.