I got my MBA back in the 1980s, but the fundamental truths about investing haven’t changed much since then. The names have changed, but the ideas have not, especially if your interest is not in day trading but in building long-term assets for retirement.
The theory says that a stock should equal the net present value of the company’s future profits. If the current price of the stock is lower, then it’s a good buy. If it’s higher, then it’s overpriced. The problem is figuring out what those future profits will be, and what they are worth today — especially since predicting profits by itself is a difficult task, and discounting those future profits to today requires a lot of guesses and assumptions.
The other difficulty discovered by behavioral economists is that all these predictions and estimates are made amidst a maelstrom of hype and emotion. Both excitement and boredom are investor enemies. Very often the best advice is to do nothing, no matter how much you want to get in on the action.
[Read: Retirement Planning Decisions You Might Later Regret.]
So as you go about picking stocks, researching mutual funds and exchange-traded funds or discussing a plan with your financial adviser, remember these five principles based on economic theory as well as practical emotional intelligence.
1. Be skeptical. Neither corporate executives nor Wall Street professionals are looking out for your best interests. They are looking out for their own best interests. So take annual reports and other company materials with a grain of salt, and pay attention to any conflicts of interest the financial analysts or TV commentators might have in the companies they recommend, especially if they own stock or do business with the company. The salesmanship around individual stocks is one reason most people are better off investing in exchange-traded funds or mutual funds instead of taking a flier on a stock that someone is pushing on TV.
2. Beware the insiders. Professionals purposely complicate financial products, at least in part to confuse the public. Insiders make money when customers don’t understand what they are buying. Instead, invest in companies that you know personally because you use the products and you know how they make money. An intriguing story about an exotic stock may be appealing, but if you don’t understand the business you should steer clear.
[See: 10 Ways to Get Ready for Retirement After Age 50.]
3. Don’t get scared. There’s risk in investing in stocks. Sometimes they can go down precipitously, as we found out from early 2000 to mid-2002 and again from late 2007 to early 2009. But despite bear markets, over the long term the stock market gains an average of 5 to 10 percent a year. So don’t let short-term problems scare you out of the market. And don’t avoid the market because you believe it’s rigged. Thanks to discount brokers, financial websites and the expansion of business media, the market is actually more transparent than ever, particularly compared to debt markets which do not undergo the same levels of public scrutiny.
4. Be honest with yourself. You’re not going to be the first person to hear about a new product or discover some wrinkle in the financial markets. And you’re not the smartest person on Wall Street. Neither is your financial adviser. Top players in the investment world work for big institutions and deal in hundreds of millions of dollars. The people who work for you are the ones who couldn’t get a job where the real money is made. You can’t outsmart the market, so just be in the market with a low-cost mutual fund or ETF.
[Read: How to Pay Less Taxes on Retirement Account Withdrawals.]
5. Get out if you’re wrong. Beware the natural inclination to cling to your initial beliefs. Even sophisticated professionals who employ supercomputers and use elegant statistical models don’t always get it right. You, too, will make some mistakes. The important thing is to recognize your errors and sell your positions before your loss turns into a catastrophe.
The stock market is always ready to take money from bold and brash traders who think they know more than they do. But remember, the stock market goes up over time, at least as much as inflation and usually more. It’s one of the few ways middle class Americans can build up a significant retirement portfolio that can produce income in retirement.
Tom Sightings is the author of “You Only Retire Once” and blogs at Sightings at 60.
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5 Lessons Business School Taught Me About Stocks originally appeared on usnews.com
