Key Points
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Investing is a lifelong process that requires constant learning.
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Diversification was not something my younger self was aware of as a possibility.
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Nor was analyzing a stock’s fundamentals before buying.
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If I could give my younger self one piece of investing advice, I’d find most of the material I’d need by reviewing my first-ever investment. My first stock was Lucent Technologies, which in 1996 was spun off from AT&T, and then bought by me at age 10 with all $500 of the birthday money I had saved up from prior years. Shortly after my purchase in late 1999, it began a long decline that saw its price fall 99.2% by September 2002.
The sting of that collapse kept me away from investing for about 15 years. So here’s the investing advice that I would give to my younger self if I had to do things over again — it’s one central theme, and it has three parts.
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1. Don’t put all your eggs in one basket
This advice seems obvious now, but new investors still need to learn it.
Funneling all your capital into one stock means one failure can wipe out most of your portfolio. Per research conducted at Arizona State University, about 4.3% of the nearly 26,000 U.S. stocks included in the analysis accounted for nearly all of the market’s wealth creation above Treasury bills from 1926 to 2016. That’s an argument for owning a large and diversified basket of stocks via an index fund like the Vanguard S&P 500 ETF (NYSEMKT: VOO).
The lesson extends to the types of assets you invest in, too. The traditional 60/40 stocks/bonds portfolio split is timeless because holding bonds can make up for underperformance that stocks experience under certain conditions, and vice versa. Today, adding some cryptocurrency into your portfolio is another way to diversify even beyond that.
2. Accept that some eggs won’t ever hatch
If you invest in a lot of different companies, some of those investments will not play out.
According to a 2014 J.P. Morgan study, 40% of Russell 3000 index stocks from 1980 to 2014 ended up experiencing a catastrophic loss, which in this case is defined as a 70% or larger drop from the peak with little recovery afterward. In the case of my first investment, in the telecom industry, the catastrophic loss rate was 51%.
The bigger point here is psychological in nature. Expecting every one of your stock picks to work out is not reasonable, but investing requires us to be rationally hopeful each time. The truth is that failure in investing is inevitable, and vastly more common than success. Quitting after the first big failure, as I did, cost me years of compounding, and not having the proper context to process the defeat in a constructive way was especially deleterious.
So when an investment does poorly, diagnose whether the cause was bad luck, incomplete or poor analysis, or something else, and then fix that and move on to the next opportunity. And then if a different investment fails, repeat the process, again and again, until your results improve. Reading about past stock market crashes can also show you how much pain is normal.
3. Understand why a stock is likely to be worth more in the future before buying it
I originally picked Lucent for my first investment because it was among the first companies I knew of in general — at age 10, I wasn’t a sophisticated investor, to say the least! Its original identity before the spinoff from AT&T was the legendary Bell Labs, one of the greatest research and development (R&D) organizations of all time, which even as a child I knew enough about to admire.
Still, I did not really have a firm understanding of why Lucent’s stock was going to be worth more (or, in this case, less) in the future. I didn’t really have an investment thesis. And while it’s certainly a tall order to develop that understanding, especially as a new investor, it’s the core of the art of investing in stocks, so my advice to my younger self would be to start grappling with these issues to the extent that it would be possible to do so at that point.
Before buying a stock, I’d tell my younger self to write two sentences: one on what the company sells, to whom, and why they buy it, and one on why its profits should be bigger in five years.
Even at age 10, I think I could’ve worked out those questions. And while that probably still wouldn’t have actually saved me from investing in Lucent, I’m sure that I’d approach the questions with a bit more sophistication in the next investment. And improving your process over the long run is the heart of the battle.
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Alex Carchidi has positions in Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
