The Fastest Way to the Poorhouse
by Dr. Steve Sjuggerud
"Speculation is an effort, probably unsuccessful, to turn a little money into a lot. Investment is an effort, which should be successful, to prevent a lot of money from becoming a little,"
-Fred Schwed, from the book "Where Are the Customers Yachts? ", 1940
As a stockbroker years ago, I saw hundreds of individual investors doing dumb things with their money.
At first, when I was certain what they wanted to do was dumb, I'd try to talk them out of it. But I quickly learned that once someone has his mind made up, it's hard to change.
While I didn't particularly enjoy being a broker, I did learn many lessons. The lessons can be boiled down to two truisms: 1.) everyone thinks differently about money. . . and 2.) people would rather be proven right than make money.
Next as a head trader, I saw the dumb things Wall Streeters do. I learned that most financial types in Manhattan don't know how to invest either. Most are actually WORSE investors than individual investors. Their primary concern is not successful investing, but extracting their cut from the customer.
Then as a head of research, I saw the "sham" of brokerage research. Most research departments exist only to come up with material that helps their brokerage employer look good; their aim is not to do, well, actual research.
It was only by working for an independent research outfit that I was finally able to crunch some numbers about what really works on Wall Street...
THE FOUR PATHS TAKEN BY INVESTORS
Ultimately, there are two conscious approaches that people take to investing. Let's call them: 1) the "GET RICH QUICK" approach, and 2) the "GET RICH SLOW" approach.
And while people don't realize it, there are two other approaches as well- 3) the "GET POOR SLOW" approach, and the dreaded 4) "GET POOR QUICK" approach.
Unfortunately, a great percentage of investors, probably most of them, actually end up using approach number four...
Here are some of the things that have consistently proven themselves to be part of the "GET POOR QUICK" approach.
MISTAKES MADE BY "GET POOR QUICK" INVESTORS
-Buying and selling options as a "novice." Getting lucky and hitting a big winner in options is the worst thing for a new options trader. That almost ensures that he'll eventually lose everything by going back for more, always looking for that big score, until all his money is gone. Options can be traded successfully - with the right tools, the right knowledge and the right advice.
-Buying and selling futures. Same story as options.
-Buying an expensive computer trading program and trading with it blindly. (If someone truly figured out the Holy Grail, why would they sell it to anyone who wanted it for just $2,000?)
-Putting all your eggs in one risky basket. Like options, if you were to happen to get lucky once, and make a zillion dollars, you'd lose it the second time around (or the third). Eventually, it will all be gone.
-Throwing good money after bad - buying more as the price falls. This is nearly always what investors do after the stock they've put all their eggs in starts to go down. Instead of getting out - or lowering their risk - they mortgage the house, the car, the family cat, whatever, just so they're not proven wrong. And if they ultimately are right (which is very rare), they'll do it again the next time around. Then they'll definitely lose it all.
-Speaking of mortgaging. . . leveraging up, using margin, or any type of borrowing money for stock trading is generally a bad idea. It's not that the debt is bad in itself. But it's generally a sign of people who are gambling. And if they lose it all, they're still responsible for paying back the money they borrowed.
Then there are a lot of just generally bad investments...
"GET POOR QUICK" INVESTMENTS
-In general, private placements are incredibly risky. If you're throwing $50,000 into a telecom startup, you should be prepared to just mentally write that money off. If it happens to turn into millions, be thankful. But don't buy that yacht just yet. . .
-Thinly traded stocks are generally bad investments. The share price may go up as you're buying, but you'll never get out when it's falling. Look for minimum average daily volume of at least 200,000 shares in stocks you're considering. But if you do get in under that volume, again mentally write off that investment. If it turns into a big winner, be thankful.
-Secretive investments. There have been tons of frauds here - offshore prime bank debentures, promissory notes, offshore investment club programs - all promising things like 10% a month or more. Folks it's just not possible.
All their secretive stuff, saying that "this is what the big banks really do with their money" is B.S. $10,000 compounded at 10% a month for 10 years would turn into a billion dollars. Even Warren Buffett can't touch that.
-Wiring money offshore. Generally, these secretive investments require you to wire money to strange lands. I saw one once promising 8% a month that was a Panama corporation with a P.O. Box in Costa Rica, asking you to wire your money to Latvia. Who do you go after when your money disappears?
By the way, I've done business offshore, managing an offshore hedge fund based in the Bahamas. If you know the people you are doing business with are reputable and have been doing business for a long time, you're probably fine. But wiring your money to Latvia on behalf of a Panamanian corporation using a P.O. Box in Costa Rica?
HOW TO AVOID THE "GET POOR QUICK" APPROACH
I could go on (and on, and on). The list of bad investments and investment mistakes is far longer than the list of smart investments. But these things described above are the major ones to avoid to keep you off the "GET POOR QUICK" track.
Below, I've included a checklist for you to follow to avoid making major mistakes in your investments.
COMMON SENSE INVESTMENT CHECKLIST
-Is the source of this recommendation trustworthy? (Do I know this for sure?)
-Have I taken the necessary steps (such as trailing stop losses, etc.) to prevent a major loss in this investment?
-Where does this stock trade? Is it widely traded enough that I will be able to sell when I need to?
-Have I verified the claims made about this stock's performance? (Do NOT rely on what a broker's research department tells you!)
-Am I sending my money offshore to people I do not know to be reputable?
-Have I done enough of my own research to know all I need to about this company?