The stupidest investment decision I ever made netted me twice my initial investment. Does this seem insane to you? Or perhaps ungrateful? Let me explain.
Some years back, while working out at a health club, a broker at the exercise machine next to mine passed a tip. Either he was feeling particularly generous that day or he was trying to reel me in as a new client. Anyway, I went ahead with his recommendation – not through him, but through a discount broker. And I dropped more money than I should have on what my broker acquaintance at the gym called a “hot new medical stock.”
Here’s why that was a dumb thing to do. I simply took the broker’s word for it. I did no research. I didn’t investigate the company’s product offering. Nor did I look at its history or competition. I didn’t even look at a balance sheet. Armed only with a stock symbol, and the name of the exchange on which the stock traded (NASDAQ), I threw money at the security as though I were a drunken sailor rolling the dice at Las Vegas. Not a smart thing to do if I were looking to create wealth for myself.
Yes it was dumb. But the reason it was the dumbest investment decision I’d ever made was that it instilled arrogance in me that delayed my learning about markets and the right way to invest. Sure, you’ve heard of speculators who day-trade profitably, but if you know one, I’ll bet you can’t name three. And probably the one day trader you do know is being less than honest with you.
The fact is that people who make money in the market buy and hold. They don’t go flitting from one great tip to the next. Had you invested $10,000 in google 10 years ago today, and held on to the stock, you’re investment would be worth $139,458.82 today.
It comes down to Warren Buffett’s sage advice: “I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.” If you follow that advice, investing becomes a gradual and sane strategy rather than a manic and defensive game.
A big reason why long-term investing is a better strategy is a matter of simple arithmetic. Let’s say an investor in the 35% tax bracket invests $50,000 in a stock. If the stock goes up 10%, she makes a gross profit of $5,000. If she holds the stock for longer than one year, she pays a long-term capital gains tax of 15%. Therefore, her after-tax profit is $4,250.
On a short-term basis, that investor’s tax liability on her $5000 is 35% — the rate of her ordinary income. Her after-tax profit would wind up being $3,250. The investor therefore has a $1,000 tax incentive to hold her stock for longer than one year. Quite a difference for a day-trader to have to overcome in his short-term strategy!
If you’re fascinated by markets, and are willing to learn and spend the time on research, you may be able to do quite well for yourself if you stick with a particular strategy – like investing in growth stocks or under-valued stocks. This kind of strategy requires quite a commitment of time. But a strategy, by which you invest in solid, broad-based index funds on a long-term basis, will probably pay off for you over the long haul. You’ll spend less time on your portfolio, and you’ll have the peace of mind that a frenetic chaser of hot stock tips will never know.