A Tale of Two Investors
Which one is the winning strategy?
This is a story of two different investors and the pitfalls that can happen with different investment strategies. I’ll call the two investors Sam and Albert.
Warren Buffett says “If a company isn’t a quality company, don’t buy it just because the price is low. Bargain-bin companies often produce bargain-bin results.” First you must look at the quality of the company, then at the price. Looking at the quality of a company can take some time as it requires that you read financial statements, listen to conference calls, and vet management. Then, only after you have confidence in the quality of the company, should the price be evaluated. So, keeping the above in mind let’s look at our first investor, “Sam”.
Sam is bound and determined that the stock market is the place that you want to be if you want to end up rich. Sam is convinced that he can make substantial wealth by taking minimal risk while at the same time shooting for that home run stock. Sam talks to his buddies and anyone else who has a hot stock tip. He gets tips on all these penny stocks that are going to go to the moon, and he is eager to invest with the thought of making millions. What Sam doesn’t realize is that penny stocks carry the biggest risk of all as generally penny stocks are companies in the infancy or startup phase of their business plan. The reality is that ninety-five percent of penny stocks end up worthless. Sure, there will be the odd “Amazon” that develops from a penny stock, but you must be the one who is lucky enough to buy and then hold for the right amount of time to capitalize.
Anyway, Sam decides to invest in some penny stocks and puts all his available cash into a handful of these future winners. As luck would have it, Sam invests in the ninety-five percent of the available stocks that are losers. A five percent win scenario verses a ninety-five percent loss scenario are not good odds at all. So, Sam’s stocks quickly end up with little or no value and he finds that he is now $100,000 in the hole. Undeterred, he saves more money and is determined that this time will be different; this time he will pick all winners. So, he gets some great advice from some friends about a stock that has been on a tear lately and he pours all his money, another $100,000 into this new gem. Within the first week he is up $1,000; up one percent in a week, that’s equal to fifty percent for a year, wow! By the end of the second week, he is up $3,000 and things are going great. He can hardly sleep at night, dreaming about how he is going to spend all the money that he is going to make from now on. By end of week three, not a good week for Sam’s stock, it stumbles a bit. Sam lost $5000 this week, now his original investment is $99,000. Oh well, he’s not worried, it will come back. The next week, the stock drops another twenty percent. Now Sam’s investment is worth slightly less than $80,000 and Sam is starting to wonder if he should just sell and take the loss. When he talks to his friends, they tell him it is just a glitch and it will come back any minute. Sam holds on, hoping that if he can just get back to even, everything will be okay. Over time his investment becomes essentially valueless. Disillusioned, Sam finally sells his stock and swears that he is done with penny stocks and will never buy them again.
Sam got caught up in the hype of easy money and although he is finally making a good decision, he has now lost $200,000 that would have been worth much more than the original amount with a different strategy. Most investors who buy penny stocks make little or no profit. “Your school may have done away with winners and losers, but life HAS NOT. In some schools they may have abolished failing grades and they’ll give you as MANY TIMES as you want to get the right answer. This doesn’t bear the slightest resemblance to ANYTHING is real life.” Bill Gates. “There is nothing wrong with a ‘know nothing’ investor who realizes it. The problem is when you are a ‘know nothing’ investor but you think you know something”. Warren Buffett.
Our second investor, Albert starts investing at the same time as Sam, but with a completely different strategy. Albert has been researching different investment advisors for a few months now to find one that he feels best understands him and his needs. He has finally found one with the experience, expertise, and credentials that he likes. He sets up meetings with them and decides which one is going to be part of his financial team. Albert also has $100,000 to invest and his advisor helps him select various investments, based on his age and life situation, which will suit him in the long-term. Because of the financial planner’s knowledge and experience, Albert can save more money at an accelerated rate compared to Sam. While Sam was making his second $100,000 investment after losing the first investment, Albert can add an additional $50,000 to his investment portfolio. “Surround yourself with good people; people who are going to be honest with you and look out for your best interests.” Derek Jeter.
If we fast forward, we can see while Sam has virtually lost $200,000, Albert’s investments are now worth about $165,000 due to his contributions and the growth that has occurred over this short period of time. Even if Sam changes tactics now, he is ultimately $365,000 behind Albert who will still have his $165,000 growing on a regular basis. Warren Buffett had only two rules for investing success, “Rule No. 1 – Don’t lose money. Rule No. 2 – Never forget Rule No. 1.”
The moral of the story: Have the time, temperament and the inclination to get informed on any particular investment that you wish to make, or find a qualified investment advisor, whose job is to be informed and knowledgeable about various investment options, to work with you. “If each of us hires people who are smaller than us, we shall become dwarfs. But, if each of us hires people who are bigger than we are, we shall become giants.” Warren Buffett.
The bottom line is that all things equal, essentially Albert has a huge lead on Sam when it comes to investing. As they move into the future, they will both continue to save and invest, but will Sam ever make up that $165,000 lead that Albert has on him. Likely, Albert will always be ahead of Sam as Albert’s $165,000 will continue to grow and that might be a big enough difference that Sam can never catch up. If Sam moves towards Albert’s investing strategy, he will reap the benefits of limiting investment losses and enhancing the possibility of substantial investment gains. It is better to have a well-informed professional on your side as you navigate the complex world of investing for success. “I don’t expect success. I prepare for it.” Ryan Reynolds (Actor)
Important Considerations:
A rare few investors make a fortune by investing in penny stocks, because as stated, history has shown that the odds are approximately 20 to 1 against you. Having a professional certified financial planner who is also an investment advisor on your team can provide many unseen advantages. I meet with all my clients to develop a plan for success to get maximum returns with minimal overall risk that suits their investment tolerance. “Risk comes from not knowing what you are doing.” Warren Buffett
