Five Investing Pitfalls: #1 Long-Only

In Ben Stiller’s parody of the fashion industry, Zoolander, the protagonist possesses a critical flaw preventing him from regaining kingship of the runway world: Zoolander does not turn left. As an avid reader of the mainstream financial media, I have noticed a similar critical flaw: many of my peers do not sell short or buy puts.

If the market can go up and down, we need to learn how to invest for up and down. Otherwise, we are like Zoolander or a car driver who turns only right: we lose ground when we need to go left. Thus, investors are not whole without shorts and puts.

I agree that shorting and buying puts has risks. However, I have read numerous recommendations in the financial media to buy homebuilders and banks while these industries are experiencing a crisis, and such buying has proven extremely risky (if not detrimental).

On the other hand, short sellers and those buying puts of homebuilders and banks have crushed the markets with superior gains. SGS has achieved gains of 21.6%, 36%, and 65% selling short Build-A-Bear Workshop (BBW) and buying puts of Blockbuster Inc. (BBI) and Martha Stewart Living Omnimedia (MSO), respectively. Consequently, investors who only buy are stubbornly losing hard earned capital and opportunities to profit in down markets.

If you are not interested in selling short or buying puts, sit tight and relax in cash while waiting for the next bull run. You can do a lot of research on potential buys while the markets are down-trending - but you must also resist the temptation to go bottom-fishing. Bottom-fishing in a down-trending market is like shorting stocks in a high flying market: you can never predict how long the irrational trend will sustain from inertia (and it’s usually much longer than your stomach or investment account can handle).

I agree that cash is a poor investment for the long run. Money market returns are not strong in the face of core inflation at 3% and healthcare-energy-food-education inflation much higher. However, a 4% money market return may be stellar if the markets go negative. Many people forgot this golden rule of capital preservation when the dotcom bubble burst. I, for one, wish I had held more cash at the time.

In addition, if you are sitting in cash watching the market whip-saw, keep in mind you need only a handful of strategic investments to score superior returns. You do not need to continue investing every time you have spare cash. If you trade too often (from impatience or a tendency to enjoy the rush), you risk making many mistakes. If you trade too rarely (from paralysis by over-analysis or fear), you risk missing opportunities. The key is to be savvy and strategic rather than fall victim to these extremes.

For example, even if you sit out of the market for the next six months, if you grab shares of KBW Bank ETF (KBE) and end up doubling your money in 3-5 years, it will have been worth the wait. A wise ancestor of ours once noted that patience is a virtue.

At SmartGuyStocks we aim to maximize our return on investment [ROI]. We are not interested in how many transactions you make (c.f., brokerage houses), we are not here to cheerlead the market and economy (c.f., mainstream financial media, government, Federal Reserve), we do not pretend to know the future (see above), and we do not stubbornly offer you one way (e.g., buy and hold) to play a multidimensional investment market.

We believe you are smart enough to follow what the market and economy tells you. We believe you can make money no matter which way the markets trend. We believe you have the discipline to step aside if things are too chaotic. And we believe you can have fun while beating the market and avoiding the herds.

If you have not already learned about selling short or buying puts, spend time surfing the web or reading some good books. If you don’t like what you read, no worries - cash is king when the market and economy starts to recover and excellent stocks are on sale. However, if you are interested in selling short or buying puts, stay abreast of what we are writing and put your toe in the waters with some small investments. As Zoolander would say, “you too can turn left!”

Comments

[TA:]

You should re-title this "Five Trading Pitfalls: #1 Long-Only"

I discovered long ago I have no ability to time the market or my stocks so I no longer try. What I do know how is human emotion and that bubble go both ways and invest accordingly.

This is a great article for those that trade but for those of us(like Buffett I hear) that do real value investing, this just doesn't work.

Many ways to make money in the market...

2008 Jan 14 11:28 AM

[SmartGuySto...:]

Agreed. There are many ways to make money in the market. This just happens to be our style. And people should always stick to what works best for them.

2008 Jan 14 12:44 PM