It is the rare investor who is able to consistently beat the market over time. The vast majority of investors make fundamental errors that penalize their results. Here is a brief summary of five common errors.
Mistake #1 - Speculating
Most investors cannot resist making guesses about whether the stock market will go up or down, what will happen with the economy, and what stock prices will do as a result. Trying to predict the future and its impact on stock prices turns investing into gambling. Investment decisions should be based on facts and logical reasoning.
Mistake #2 - Making emotional decisions
Headlines and popular opinions about the economy or individual companies as well as short term stock price movements have an emotional impact. Reacting to those emotional impacts results in poor decision-making. Investors must learn to set aside their emotions, ignore the opinions of others, and focus on a business's fundamentals and performance. As Ben Graham said, you will be right when your facts and reasoning are correct, not based on whether others agree or disagree with you.
Mistake #3 - Ignoring competitive threats
It is not enough for a company to have a great product or service, or for it to be in a great industry. A company that does not have durable competitive advantages will not create shareholder value. It is essential to understand a company's ability to withstand competition and disruption.
Mistake #4 - Not comparing intrinsic value to price
As Warren Buffett has often said, price is what you pay and value is what you get. Buffett also emphasizes the importance of having a margin of safety between the underlying value of the business and its stock price. A great business at a reasonable price is better than a mediocre business at a great price, but overpaying for even a great business will punish returns. Comparing price to intrinsic value is crucial to making investing a business-like endeavor.
Mistake #5 - Over-diversifying
Most investors hold too many companies in their portfolios. This leads to careless behavior. Investing in a small number of companies forces an investor to be more selective, own only the best companies and avoid expensive mistakes.
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