Motley Fool: Five investing concepts you might be getting wrong – The Sydney Morning Herald

  • Scott Phillips

“You keep using that word”, Inigo Montoya said in the movie The Princess Bride, “I do not think it means what you think it means.”

He might have been speaking about the financial services and investment industry.

</p>  Photo: Gabriele Charotte

Risk

If there is one word that has been more completely hijacked, and redefined (badly) by the finance industry, it’s risk. You and I know what risk is in the real world: the chance of something going very badly wrong, which can be treated, but not undone.

Financial types would have you think that there is such a thing as ”upside risk”, which tells you all you need to know. When something moves around a lot, it’s called ”volatility”. Not risk. The former is inevitable. The latter should be managed.

Diversification

“I’m diversified. I own shares in five banks and three miners.” No. No, you’re not. “Well, I own Woolies and Wesfarmers as well.” So, 85 per cent of the Australian grocery industry …

Diversification isn’t just owning a lot of different companies – it’s owning companies with different risks, different characteristics, in different industries. If one event, occurrence or decision impacts more than 20 per cent of your portfolio negatively, you’re not diversified.

Charting

The share price has just gone (up/down), so it’s going to … behave randomly.

Humans are pattern recognition machines. We evolved to learn that way. And as we evolved, a false positive was better than a false negative. If it looks like a lion and sounds like a lion, it was smart to assume it was probably a lion.

Sorry. It’s tempting to think you might be able to look at a chart and work out what will happen next … but the evidence just doesn’t support that theory.

Blue chip

This is finance industry code for “companies that I can convince you to buy because they’ve been around for years and you recognise the name”. That’s a mile away from “companies I’m genuinely convinced are likely to be market-beaters and belong in your portfolio”. The easiest sale to make is the one the customer already thinks they want to buy. “Advice” is telling them the truth, uncomfortable or not. The rest is “sales”.

Keep your reverence for only the companies that deserve it. The ones that earn their spot in the investing pantheon by way of great returns, not just familiarity or longevity.

Patience

Less a concept that people misunderstand, and more one that we struggle to implement. You know who makes money when we fiddle with our portfolios? Stockbrokers and the Tax Office. Too many studies to list have shown that managed funds tend to underperform, but individual investors underperform even the managed funds they invest in, because they can’t leave well enough alone, always buying, selling, chasing the last ”big thing” or punting on the next one.

Choose well, add regularly. Keep your costs down. Let compounding really, truly, work for you. And if you haven’t got started: do it. The longer you have – and the more patient you are – the better off you’ll be.

Foolish takeaway

In the movie, Inigo Montoya eventually has his revenge. He did it his way, but I’ve always liked George Herbert’s line that “living well is the best revenge”, instead. He might have said ”investing well”, too.

If you can remember some of these concepts, you’ll be well on your way.

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Scott Phillips is the Motley Fool‘s director of research. You can follow Scott on Twitter @TMFScottP. The Motley Fool’s purpose is to educate, amuse and enrich investors.