Bill and Ted's Excellent Investing

Today we have a guest post on investing from a new blogger: Islands of Investing. Hey, where are you going? Wait! Don't leave! I know your first instinct when being told of a guest post is to click away and read some other post from one of your old standbys. But this is a legitimately good post on investing, and the mistakes we can make with our money. If you don't stay and read it, you will probably be poor and unpopular forever, and will likely regret this one key decision when you look back on your life from your deathbed.* Don't let this day be another wasted one, filled with feelings of what might have been. Carpe...something.

*Disclaimer: reading this post will probably not have any material impact on your wealth, popularity, or anything else. The blog does not recommend any specific form of investing, such as picking single stocks. Like everything on this site, the following post is for entertainment purposes only and should not be considered investment or financial advice. Consult real professionals before making financial decisions.You have been warned.

If you’re on a mission to become financially independent, you’ll already know that investing is an important part of your plan – both in getting there, and in keeping you there.

The great news is you have the potential to be a fantastic investor.

Unfortunately, many people doubt their own abilities. One of the big reasons for this is they think the secret to success is to ‘pick the winning shares’ – the next Apple, Amazon or Google. Like trying to hit the jackpot, or find Willy Wonka’s golden ticket.

If you’re one of the many people who believe this, you may never have even tried to become a good investor. But picking the next big thing is not the answer to your investment dreams – even if you could pick it.

To understand why, I’d like to share a story about two investors*, Bill and Ted, who both bought some shares in a fantastic company called XYZ 10 years ago, at a similar price….

Bill’s investment in XYZ

Bill bought 10,000 shares of XYZ at $0.50 each (a total investment of $5,000).

Bill held his shares for 10 years, never selling or buying more (he doesn’t watch much news, doesn’t check share prices that often, and doesn’t trade often. Although he is pretty busy living a great life…)

XYZ turned out to be a great success. Today the shares are worth $10 each. Bill’s $5,000 investment is now worth $100,000. Wow. Great share picking Bill!

“If only I was lucky enough to pick those shares!” I hear you say. Well, Ted was also lucky enough to pick them, but his results were a little different…..

Ted’s investment in XYZ

Ted heard about XYZ from his favourite share investment newsletter. He watched it for 12 months, because he didn’t know whether it was really a good investment – he doesn’t have his own criteria to test it against.

Only four months later, it has risen 70%, and everyone in the media is talking about what a great share this is. Nearly all brokers recommend it as a buy. So Ted jumps on this bandwagon and buys for $0.85.

Things go well for the next 6 months. His shares are up 15%. But he’s been reading in the news that ‘the market’ is worried about China. Sounds serious. Over the next week, ‘the market’ is down every day, falling a total of 6% over the week. XYZ falls 8%. Ted is nervous. He sells. “7% gain – can’t complain about that!” (before taxes and transaction costs).

He keeps watching XYZ out of interest. Over the next 2 months it falls a little below the price he originally bought. “Phew, glad I sold when I did!”. He pats himself on the back.

Three years later, XYZ has had some great success, delivering increased profits and dividends. Ted had forgotten about this investment, but since it’s in the news again it’s back on his radar. “There’s no way I want to buy now though – it’s up 300% on when I sold it! I’d only buy if it got much closer to that price again!”. He’s anchored to his previous selling price.

The success of XYZ continues. There are some small share price drops occasionally over the next couple of years, but the share price continues its trend up. Turns out to be a pretty great investment after all, and still at what appears reasonable value. But Ted still refuses to invest. He can’t possibly buy these shares now and admit he made a mistake selling them many years ago.

A full eight years later, and ‘the market’ is doing fantastically. Everyone’s talking about how great shares are doing, including XYZ. Almost every broker has it in their ‘top 3 best buys’. They’re saying it could rise another 20% this year. Even Ted’s friends recently bought some shares!

Ted’s missing out on the gains. He feels the pressure mounting. He hates this feeling of missing out.

So he bites the bullet and buys (and why not, after all he has some funds available – he just recently sold some shares in another potentially great business, BCA, for a nice 10% gain (before taxes and transaction costs). “Yesss!”).

 Aaaaah. Pressure gone. Now just ride the wave to riches.

Nine months later, there’s a market wide ‘correction’ – news of a civil war breaking out in some Asian country has everyone nervous and selling. XYZ is now down 8% from what Ted paid. He decides to sell when it gets back up to his purchase price (he hates making a loss!). But each day it slides a little more, and each day his stress mounts. 10%. 12%. 13%. 15% down. Panic stations! Ted sells. He can’t take it.

Three months later, the potential war is long forgotten. XYZ is back above what Ted originally paid. The world seems great again. But not for Ted. To top it off, those shares in BCA he sold about a year ago are up a further 35%! Damn it!

Ted gives up. He’s just no good at picking shares….

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Your past experiences probably won’t be exactly like either of Bill or Ted’s. You might laugh at Ted’s terrible investing abilities, or you might recognise some similar experiences with your own past. Although like Ted, you might not even realise that you had previously invested in some ‘winning’ shares, unless you’ve revisited some old investments.

But the point is that you can achieve drastically different results when investing in the same share. The share itself is not the answer to your investment dreams. For XYZ, your returns could have been anywhere between a large loss (with frequent trading) and a 2000% gain.

Where you fall in this range will depend on your own plan, strategy, investment criteria, skills, experience, ability and attitude (and of course, a little luck).

This is also not to recommend buying and holding shares forever as the best approach (but I think it’s a reasonably good one). But it’s an approach that suits Bill, and has worked well for him in this example. We could pick another example of a terrible share investment that has been declining for the past 5 years. If Bill did the same thing, he would most certainly lose money, whilst it’s possible another investor bought shares when they were significantly undervalued, and sold then for a gain when they were ‘reasonably’ valued, despite the broader downward trend in the share price.

Consistency is waaaay more important than hitting one home run. Just like winning the lottery won’t necessarily make you rich (for long), and is very unlikely to change your ability to manage money well – we’ve heard all the stories of people hitting the jackpot one way or another, and being right back where they started after a few months or years.

So by all means, seek out great shares to invest in. But more importantly, continue to develop your own plan and investment criteria, and your investment skills. Because whilst picking winning shares can be fantastic, it is not the main game of investing – you don’t need to pick the shares of the decade to achieve great success. And as Ted will tell you, picking great shares does not guarantee great results.

* Purely fictional characters 

Photo of Bill and Ted, which is oddly the only one I could find on Flickr, is from Sylvar at Flickr Creative Commons. If you'd like to read more from Islands of Investing, you can find his blog here.