Today we have a guest post from Troy Bombardia. Troy runs a small hedge fund that’s closed to outside money. He uses a quantitative approach to
invest in S&P 500 ETF’s. Find out more on his About page.
I was a teenaged investor, and my finances survived the experience. In my first year of investing, I learned a lot of things and skills about the markets that you would never learn from a book. I’d like to share them so you don’t make those same mistakes.
My dad had his own business, and often times I would go down to his office and watch him work. At the dinner table, we’d often discuss the latest issues around the world after talking about the obligatory “how was your day at school” stuff. Some of my family and family friends worked in finance or had finance-related businesses. One summer I went to work as an assistant at one of these hedge funds, and I was hooked on the markets. I opened my own brokerage account as soon as I turned 18.
I lost some money, but, fortunately, I didn’t have a lot of money to lose. Here are a few lessons that you can learn from my mistakes.
My position sizes were way too large
In my first year of investing I focused on 3-4 stocks. One of these was a clothing company. I bought the stock because it was “cheap” and had a low P/E ratio. Unfortunately, the company witnessed quarter after quarter of declining earnings The stock sank slowly but steadily.
Looking back, I made the wrong decision to have such concentrated stock holdings. As a beginner, I should have diversified more.
Many books like Hedge Fund Market Wizards advise investors who are just starting out to shrink their position size. The 5x inverse rules states that if you want to invest 50% of your portfolio into a stock, invest just 10% into it. As a beginner, the key is to learn as much about investing as possible, not to make as much money as possible.
I don’t diversify my portfolio nowadays, but that’s because I know what I’m doing and have many years of experience in the markets. In addition, I invest in UPRO, which is an index fund that’s tied to the S&P 500. It’s akin to spreading out my money over 500 stocks.
Do not buy a stock just because it’s cheap (if you’re looking for capital gains)
A “cheap” stock with a low P/E ratio is often cheap for bad reasons.
Unless the entire market is cheap like in 2009
, a single stock that’s cheap stands out like a sore thumb. It’s probably cheap because the company faces significant challenges to its business
As an outside investor with little or no contact with management, you probably have no idea whether the company will solve its challenges or not. If the company doesn’t solve its challenges, the stock will either continue to be “cheap” or will start to fall. If the company solves its challenges, the stock will rise.
It’s a 50-50 bet that savvy investors should not take.
Don’t buy penny stocks
I had a friend who was interested in the stock and real estate markets as well, and we’d often share our research or the latest financial news with each other. One day we stumbled upon this tech stock that really caught our eye. It was a small database tech stock that seemed like it was on the verge of announcing a big new product. I remember it vividly: it was selling at $0.7 per share, and being the young bulls that we were we both bought a lot of this stock.
In a matter of weeks, the stock rose to $1.3. We felt like geniuses. Then over the next few months, it slowly drifted down to $0.4. The frustration was real and we just couldn’t see why the company’s product announcement was being delayed.
It turned out the company was having significant difficulty developing the product, so the stock bounced in a big range around our entry price. By the end of that year, we sold the stock in disgust at a small loss.
The moral of the story is that you should never, ever buy penny stocks. This company had a market cap of only $10-$20 million at the time.
- Penny stocks are insanely volatile. You can easily lose 80% of your money or triple it in a span of a few months.
- Most penny stocks are penny stocks for a reason. This is usually because the company is still in its startup stage and has yet to book any real earnings. Most of these penny stocks don’t make it out of that startup stage and die out eventually.
So unless you treat the stock market as a gambling machine, don’t buy penny stocks. A few penny stocks turn into great success stories but most go bankrupt.
Lessons from a Teenaged Investor
As you can see, some of this advice goes against conventional thinking. We’re taught from Day 1 to always buy “value”. But there is no standard definition of “value!” That’s why you need to do your own research because everyone looks at things differently.
In addition, it’s important to remember that there are no hard and fast rules in investing. The rules that you should adhere to will evolve over time depending on what markets you invest in, your investment strategy and your investment skill level.
What was your first investment? Did you make or lose money on it? What lesson(s) did you learn from that experience?
*Part of Financially Savvy Saturdays on brokeGIRLrich.*