How Not to Invest in Stocks: Learn From My Stupidity

So, on Wednesday, I sold my first ever stock, Novartis. In the process, I made at least one key mistake.

The stock had tanked after its Tuesday earnings call announced that for the next year it would be having slower than expected growth. This had been somewhat expected by analysts, but regardless, the stock still dropped almost 3% on the news.

On Wednesday, the stock dropped a further 2% based on several analysts dropping its rating. Importantly, the analysts did not have any information the market didn't have on Tuesday. Their downgrade was based on the Tuesday earnings call, which the market had already reacted to.

On Wednesday, after the stock had dropped more than 5%, I sold my stock. On Thursday, the stock rebounded 1.8%, mostly because some analysts held steady on their rating while others realized that that the Wednesday analysts didn't know anything the Tuesday market hadn't already known.

The end result is: I sold at the low. I still feel like it might be 8 months before the stock starts appreciating at a decent level. I should have either sold on Tuesday after the earnings report, or I should have held onto the stock until it came back from its Wednesday's loss.

Lessons Learned from Investing Thus Far

So, I have only been in the investing game for a little while thus far, but, even though my stock has been tanking, I have already learned a lot of really good lessons.

The main thing I am starting to learn is to get a better picture of the investing world. Basically there are the institutional players (Wall Street) and then the rest of us (Main Street).

For any large cap stock, there is almost no way that Main Street can out-know or out-smart Wall Street, so there is usually never any type of sure thing among these stocks.

To outperform Wall Street, you have to take on a lot more risk by wading into smaller caps or options or other risky areas. However these seem like very risky waters, and I am going to be wading into them very cautiously.

The other lesson I have learned from investing is the basic mechanism of trading. Things such as never placing market orders (always place limit orders) and the other nitty gritty of how to trade.

New Use for Zecco: Selling at a Loss

My first stock has tanked since I bought it. I'm not really sure why, though there are a couple of possibilities. I still remain optimistic for the long run.

But it strikes me that it might make some sense to sell the stock at a loss right now, and then turn around and buy it again. This would cement my losses on my tax returns, but have no other effect on my bottom line.

Short term tax gains and losses are taxed at my marginal rate (33%), whereas long term gains are taxed at the capital gains rate (15%). Thus if I sell at a loss, I can deduct a higher percentage from my income, then if I waited and sold at a loss after a year.

With Zecco being so cheap to buy and sell, the transaction would cost me very little, yet result in favorable tax treatment.

Alternate Income Streams: Betting Against Zealots

I've been exploring whether to start investing money in the political futures market, sites like Iowa Electronic Market and Intrade offer people the opportunity to "invest" in a bet which functions like a stock on certain political candidates or parties winning elections or primaries.

The great thing about these markets is that they are populated by partisan hacks of both sides, who cause tremendous inefficiencies which can be exploited for profit.

For instance, based on fundraising totals it seems pretty clear to most people that the Democratic primary will be won by either Hillary or Obama. Sure you could make an argument for Gore or Edwards, but the former seems disillusioned with politics and the latter seems hopeless, despite his popularity with the Daily Kos.

If I bet on those two candidates to win the primary (placed bets on both of them), and one of them won, I would make a 25% return on my investment. If I wanted to temper my risk by also betting on Gore, I would make a 15% profit.

Unfortunately, the same inefficiencies don't seem to exist on the GOP side, as a bet on Fred Thompson, Giuliani, and Romney would only return 16%. A bet on John McCain (whose campaign is in freefall) would return a healthy 1,983%, which despite McCain's freefall seems a bit exaggerated.

I am a Daytrader (Apparently)

Zecco is an unbelieveable thing. On Friday, I had $20 to spare, so off the basis of some stock blog's tip I invested $19.80 into one share of ARGN- which I have no idea who they are, or what they do. The stock soared, and I was able to promptly sell the stock at $20- a 1% profit in a day.

Yes the $.20 I made is definitely not worth the extra amount of effort I created for myself in reporting that $.20 to the IRS, but I view it as a valuable learning experience.

The more experience I build up with trading, the better I will understand how I should be executing my orders. Hopefully, that $.20 will pay off big time.

Investment Newsletters- Are they Worth It?

I keep reading Motley Fool's promotional material about how their Hidden Gems newsletter has returned ridiculous profits, and it appears very tempting. I would love to read some reasons why I should NOT buy a newsletter though.

Here's what I have been able to come up with:

1. Risks- This is not free money, with the possibility of great returns comes the possibility of great risk. Any investments in their small cap value stocks could easily tank by more than 50%.
2. Cost- At $175+ you are basically paying a tremedous cost on any type of small investments. However, given the risks involved, you would be ill-advised to put too many of your assets into their reccomendations.
3. First Mover Advantage- In order to maximize your returns, you probably need to invest as soon as the recommendation comes out to get in on the reccomendation bump, this might cause you to do less research and cause you to make more mistakes.
4. Newsletter Bait and Switch- I suspect that the Motley Fool, like other newsletter companies, has newsletters that tank. They then discontinue the tanking newsletters and make it look like they are brilliant geniuses for having so many newsletters that outperform the market.
5. It could be a short-term fluctuation-It could be the types of stocks they are reccomending are on a temporary high and are headed for a crash.

Thats what I have been able to come up with, I would love to hear people's thoughts on this.

My First Stock

I wasn't planning on buying my first stock until I had paid off my student loans, my second mortgage, and also built up a stable of solid index funds to form the base of my investments, but plans change.

I stumbled across a stock that I really liked, Novartis (NVS), and the more I read, the more I liked, and I decided that all things considered it made sense to enter now. I bought 62 shares out of my Zecco account and it all went smoothly (though in retrospect I should have used a limit order, rather than a market order)

Here's my thoughts on the stock:

1. I like their business prospects- Its a global pharmaceutical company which stands poised to capitalize on the greying of the baby boomers in developed countries. While it suffers from the threats facing most pharmaceuticals (expired patents, increased competition from generics, increased lawsuits, increasingly regulatory climate) for various reasons it appears to be in a better or equal position vis-a-vis these risks than its competitors.


2. Analysts like it- It has a 5 star rating from Morningstar and S&P, and the talk on the Motley Fool's website has been pretty positive.


3. The stock doesn't seem to be overpriced- The PEG is like 1.25 and the P/E ratio and other measures don't seem to make it overpriced. Most analysts fair value of the stock is higher than the current stock price.


4. No looming problems- It seems to be dedicating a significant portion of its revenues to R&D, and doesn't seem to have a large debt problem.

Of course, this being my first stock purchase, it's very possible I don't know what I'm doing. Only time will tell.

Time to Raid the Emergency Fund

I have located my first ever stock that I would like to invest in (if you don't count the time my dad let me buy one share of General Mills when I was 10 because I liked their cereal). I read the Morningstar reports, the Standard & Poors reports, and the company's 20-F (the foreign equivalent of a 10K), and even logged into the motley fool forums to get a feeling of what people thought.

I've opened up a Zecco account, but now I have to fund it.

I will probably raid the emergency fund assuming I can figure out a way to set up a Zecco to FNBO Direct transfer. Lets hope our beat-up old car holds out for a couple of months.

Should You Try to Time the Market?

I recently found this post arguing against the Buffett style "buy and hold" investor. Citing to a book by Ben Stein, the post argues that the whole "no one can time the market" advice is an oversimplification, and that by working the numbers you can avoid predictable decreases and cash in on predictable upswings.

Specifically, buy whenever the following valuation ratios fall below their 15-year moving averages: price-earnings, dividend-yield, price-book, price-cash flow, and price-sales.

It strikes me that the two are not mutually exclusive. A value investor like Buffett takes the value of the stock at the time of purchase into account when he buys it, thus in a way he is timing the market.

When to Sell

The difference comes down to whether to sell or not when the stock becomes overvalued. Buffett's advice is usually reported as "sell rarely, if ever," but this does not seem like a prudent course for the ordinary investor.

Unlike Buffett, I can't run the companies I am buying into so as to ensure high returns on my investment. If my stocks become overvalued there is little I can do to maximize my return except sell and invest elsewhere. Of course, I might miss out if the company's long run growth remains stellar, but there is nothing preventing me from buying back into the company once it becomes less overvalued.

The buy and holders have a legitimate point, however, when they emphasize not overreacting to short term swings in the stock price and selling like a panicked feline. I am going to try not to panic at the first downswing.

I Need To Learn Faster

The NY Times has an article reviewing the new Apple IPhone, and it's clear that it will be truly revolutionary: a combined cellphone, video IPod, web browser, email terminal, camera and status symbol. All of these functions will be performed at the highest echelons of quality and style.

Before the success of the I-Phone was as manifestly obvious as it is now, Apple's stock price appropriately quadrupled over the last year, meaning that much (if not all) of the new sales and market share represented by the IPhone is already reflected in the stock price.

Before I start investing I am going to need to find a way to learn about companies faster, before their successes become front page news.

It may not be possible to outsmart the market, but it certainly is possible to be outsmarted by it. To avoid that happening, I need to be able to get as much information and knowlege about companies before it becomes manifestly, front-page, obvious.

The most obvious place to do that, the internet, seems to be the most unreliable. In order to weed through the sea of BS, I will need to have a lot of general and background knowledge on stock investing and on the business of the companies I invest in.

Hopefully then I will be able to spot the next I-Phone before it becomes obvious to everyone.

5 Problems With Prosper

Would you loan to this listing?

So a friend of mine was very involved with Prosper, and has wanted me to get involved. Here are 5 reasons why I will not be.

1) Higher Default Rate Than Average - borrowers tend to come to Prosper when they can't get funded elsewhere. Additionally, there are other moral hazard problems, for instance some borrowers take the money lended to them as charity, with no intention of paying it back. The result is borrowers on Prosper have a higher default rate than the average person with a similar credit rating.

2) Taxes- Loan interest is not taxed at the long-term capital gains rate, and is instead taxed at your marginal rate. This can make a huge difference in your after-tax return. Additionally, Prosper delays in declaring loans in defaults, which hurts your ability to offset those losses on your income.

3) Poor Customer Service- Prosper has taken some steps to address problems, but if you read the message boards, their are certain problems, like group leaders who are gaming the system, which remain unresolved.

4) More Serious Lenders than Borrowers- A year or two ago, lenders would lend to anyone, based on their story. Having gotten burned on that approach, lenders are increasingly wising up and are pre-limiting their lending to borrowers meeting certain financial criteria. This creates a glut in lenders for the good listings with a resultant driving down of interest rates and returns.

5. State Credit Laws- Some states cap interest rates in an attempt to stop usury, but all they accomplish is that they make certain highly risky people, unloanable, since borrowers cannot charge an interest rate that properly reflects the risks involved.

How to Learn About Investing (For Free)

A half year ago, I couldn't tell a P/E ratio from a PE class. I am not even close to being ready to start investing in individual stocks, but I think one of my strengths is my ability to realize this and start the process of teaching myself how to invest.

Here are the Steps I have taken thus far:
1) Books- I've read the Motley Fool's Investment Guide as well as another Fool book, which wasn't as good. Other books I have read: A Random Walk Down Wall Street, Kiplinger's Guide to Investing, some Cramer books as well as some others which I wouldn't reccomend to my worst enemy (Someone's Rich Dad apparently never taught his son how to write in clear English). I checked these all out from the library.

2. Warren Buffett's annual letters to Berkshire shareholders. Everyone reccomends these as a great way to learn how to invest. I've only read 2 thus far, I am going to try to read as many as I can.

3. Stock Investing Blogs & Websites: I try to read Marketwatch, the WSJ, Motley Fool Online. and a couple of blogs every day. One Million to My Name has a great blog for stock investing where he runs through his successes and failures on a regular basis and you get the benefit of his experience.

4. Morningstar Classroom: This is huge, Morningstar has an online free classroom, where you can teach yourself about every major investment topic, and afterwards you take tests to test your knowlege. If you get enough points from the tests you qualify for premium trial membership.

5. My local library's website: I can access Standard & Poors' stock reports as well as Morningstar's stock reports online through my library's website (with my library card number)

6. Fantasy Stock Portfolio: There is no subsitute for experience. I have several fantasy portfolios, where I am learning from my successes and failures. For instance, acting on a "hot tip" from a blog, I converted 10% of my fantasy portfolio into MEDX, a biotech I knew almost nothing about. It promptly dropped 10%. Lesson learned: there is no such thing as insider or pseudo insider information, and there is no subsitute for doing my own due diligence.

Investing: What Not To Do

So, as I have mentioned, I am a definite newbie when it comes to investing, however, having spent a lot of time researching and learning over the last year, I've come to some definite conclusions as to what I should not do, when I begin investing in a couple of months.

1. Giving Up or Hiring Financial "Advisors": I have a friend at work who has $75K in his checking account and is too busy and/or clueless about what to do with that money so he just lets it sit there. Obviously for him, a financial advisor would be a step up from the status quo. For the rest of us, however, the high fees they charge (which is before any fees you also have to pay from mutual funds and investment products), make these "professionals" easily beaten by do-it-yourselvers with the patience, time, and willingness to learn about investment. I have no interest in paying someone 1% of my total assets every year to "manage my money," by failing to beat the S&P.

2. Fee-Heavy Investments: I similarly have no interest in investing in other fee-heavy investments: front or back loaded mutual funds, overly high expense ratioed mutual funds, insurance annuities, or overly expensive brokers to hold my hand while they overcharge me (cough cough Charles Schwab). The internet age means none of these products are needed.

3. Individual Bonds: I have no real time to learn about the complicated and subpar-performing bond market. Long-term Bonds are usually highly risky (though lesser returning than equities) while short-term bonds pay peanuts. To paraphrase Warren Buffett the only good day to invest in bonds is on a day that doesn't end in the letter "y." While I may invest in a few bond mutual funds (like an indexed fund) to hedge against a stock market downturn, I have no intention of overdoing it.

4. Investing Too Conservatively: The key to good investing is assessing risks and determining which paths present the best opportunity, given the risks, to achieve maximum rewards. Keeping a 12 month emergency fund or paying down your mortgage is not a reasonable assessment of the risks presented by investment. Passing up reasonably risky investments is a far too fearful strategy to achieve investment success, and is guaranteed only to lead to subpar returns and high opportunity costs.

5. Not Taking Advantage of Tax-Favored Investments- IRAs, 401Ks, etc.: These offer massive tax benefits, which work out to be free money (especially if you have an employer matched 401K), and turning them down is a huge mistake. My NYC friend, despite my advice that he do so, has failed to create & contribute to a Roth IRA. If he had done so for the last two years (contributed $8K) that $8K (assuming a 10% return) would have returned about $256K in 36 years (when he turned 62). If he is taxed at a 28% federal rate and a 6% state rate, then that Roth would have saved him around $87,040 in taxes.

Bonds? What are they good for?

So I was reading this great Ben Stein article, and he mentioned that he has no bond holdings in his portfolio. Instead he has 20% of his money in cash, i.e. money market funds, CDs, etc.

I read somewhere that there has never been a 10 year period where the average return on bonds has been better than the average return on stocks. This seems to imply that if you are investing for 10 years down the line or more (as I am), you should not own bonds.

Right now I have no bonds in my portfolio, but as I start investing outside of my 401K, I am torn between the feeling that I need to diversify in case stocks tank, and by my concern that I would be sinking my long term rate of return. I am not sure what investment vehicles out there are better positioned as a hedge against a falling stock market.

My plan right now is to invest around 10% of my portfolio in tax-free municipal bonds, which make sense given my temporary high income tax bracket. The question I have is:
Is this small risk hedge worth the drag on my total rate of return?