Read this interesting piece written by Brett Arends and I believe its a must read for all....
What are the biggest investing lessons of the past decade? It's been a tough and turbulent ten years, but if we begin the next decade wiser as well as older then maybe it won't all have passed in vain.
For me, these are some of the main takeaways, lessons and reminders of the past few years.
The price something used to be is irrelevant. Just because a stock traded for $100 six months ago doesn't mean it's cheap at $50, or $20, or even $1.50 today. Think of technology stocks from 2000-02, bank stocks from 2007-09, and so on. The same is true, with some extra zeroes, for Miami real estate. Psychologists call this "anchoring" -- we let previous prices influence our views of current value. It's a menace, possibly the biggest peril facing private investors. (The corollary is that market bubbles give you plenty of time to get out when they start to deflate, but too many people hang around because they believe that things can't get any cheaper.)
Have a portfolio that doesn't keep you awake at night. For real people with real lives, investments that let you sleep at night are far more valuable than exciting speculations that offer "pin action" and "momentum". We've just seen why. If we really understand and trust an investment, we're more likely to hang on to it or even buy more, in a crash. This is a much-overlooked advantage to investing in companies like, say, Diageo (Guinness beer, Smirnoff vodka) or Kraft Foods (Kool-Aid, Jell-O) or ExxonMobil. If you owned them in 2000 and 2006, you were less likely to dump them when things got tough down the line. That's one reason I'm still wary of buying financial stocks in any environment, even if they are cheap.
Beware the phrase "relative value." It's the financial equivalent of "half pregnant"—pure nonsense. Value is value: It's absolute. An investment is inexpensive in relation to its future cashflows, or it isn't. But in every boom, many people are suckered into paying way too much for an asset on the basis that it's cheap relative to other (even more overpriced) assets.
Have the courage of your convictions. Today's investing geniuses started the decade looking like idiots, because they held old-fashioned value stocks, emerging markets, gold and commodities. These investments slumped for years while the likes of Cisco and AOL made countless paper millionaires. You can look wrong for a long time before you look right. It was ten years ago this winter that some of those value stocks hit rock bottom: solid blue chip companies were boasting 10% dividend yields, but hardly anyone wanted them. The brave made a fortune.
There is no substitute for saving. Sounds obvious, yet for most of this decade the U.S. savings rate has been on the floor. Hard to believe today, but earlier this decade some commentators argued that Americans didn't really need to save more because they were making so much money on their stocks and homes. Saving money is like losing weight. There are no reliable shortcuts. Whatever you make, spend less.
Never confuse a trade with an investment. If you want to speculate on the next bubble, it's up to you. Although risky, bubbles yield the easiest and biggest profits. Just remember it's a trade, a short-term holding, not an investment, which you should expect to hold for years. Just be sure to get out in time. Earlier this decade, too many people decided to call their tech stocks long-term investments once they started tanking, in effect turning a short-term loss into a long-term disaster. (Oh, and a corollary: Never be afraid to take a loss on your trades. The willingness to take a 20% loss may save you a 100% loss).
Daily headlines are less important than long-term trends. The investors I know who made a lot of money this dismal decade usually did so by understanding long-term trends--the effect of Chinese economic growth, supply and demand in the gold market, or burgeoning U.S. debt. Yet most private investors aren't interested in these long-term stories. They want to hear about short-term news -- quarterly earnings, takeover talk, market "action" and so on. What do you think investors paid more attention to back in 2001 -- Cisco's latest update on industry conditions, or the gold price? In retrospect, which turned out to be more interesting?
You can't time the market perfectly, but you can usually value it accurately. Investing more when assets are cheap, and less when they are expensive, is both doable and profitable. If you are patient and use dollar-cost averaging to smooth your way in, you will generally make good money over time. The finance industry repeats the self-serving mantra "you can't time the market" to keep you fully invested all the time. That's true in the narrowest sense that you usually can't pick the perfect moment when things will turn. But you don't have to.
Take expert forecasts with a grain of salt. In February 2008, fewer than half the economists surveyed by the National Association of Business Economics said they expected a U.S. recession that year; those who did expect a downturn predicted its effects would be "relatively muted." What is remarkable is not merely that the actual recession proved the worst since World War II, but that by the time of this survey the economy was already in recession (according to later reports). The opinions of stock analysts can be similarly fallible, especially when most analysts seem to agree. A case in point: At the peak of the housing bubble, when home-building stocks were at crazy valuations, most construction industry analysts were bullish.
You have to stay in the game. One danger from the last ten years is that people will walk away from investing altogether and instead keep their money in the bank. It's a terrible idea. Cash is a very poor long-term home for your money. After taxes and inflation you'll be lucky to come out ahead. Inflation remains the quiet menace that investors too often underestimate. This has been a "low inflation" decade, when the consumer price index has only risen by a pretty modest 2.6 percent a year. But even at that rate, the purchasing power of a dollar has still fallen by about a quarter since 1999.
Never confuse the unlikely with the impossible. Ten years ago it seemed unlikely that Enron and WorldCom (and Bernie Madoff) were giant frauds, or that oil, recently $10 a barrel, would rise to $140, or that gold would skyrocket above $1,000 an ounce, or that stocks in boring "old" Europe would outperform Wall Street. Even five years ago few imagined real estate would crash nationwide, or that Bear Stearns and Lehman Brothers would collapse, or Fannie Mae, Bank of America and AIG would all need a rescue. Yet all came to pass. It's a fair bet that some of the things that happen over the next ten years seem just as implausible today.
