A man I knew a few years back got seriously into real estate after reading “Rich Dad, Poor Dad” and inheriting a million dollars (his father-in-law died). He had been living in Toronto, and after discovering how much cheaper property was in smaller towns (duh) he started buying anything he could get his hands on (this is the guy who evicted me when I wouldn’t loan him money).
I was talking to him after he’d bought one building with a commercial store front. I asked him if there was a tenant in it when he bought it and he said “no”. I then asked him if he had a tenant who would go into it after he fixed it up, he again said “no”. He followed this up with saying there was a non-profit group he could let use it in order to get a tax credit. I asked him why he bought it if there wasn’t any clear way to make money with the building, and he said that it was so cheap, he couldn’t lose. After he fixed it up he could just resell it for a lot more than he paid if he couldn’t find a tenant (although he expected to have people want to rent from him).
At the time this didn’t add up in my mind, but I figured I must not have a proper understanding of real estate. If the property was selling cheap now, it’s because there wasn’t much of a demand for store fronts in the small town. It just seemed to me that he was buying a rock around his neck to get the property, pour a lot of time and money into it, then have it sit empty for him (like it was for the person who sold it to him).
He proceed to buy up a bunch of properties, went looking for more money to keep buying (enter Mr. Cheap) and just recently, a few years later, I’ve found out that (surprise, surprise) it hasn’t worked out very well for him.
There’s a funny thing when people first get into a new investment, they seem to convince themselves that they’ve somehow stumbled in on it at exactly the best possible time. He was convinced that for some reason real estate was available at an unbelievably good price and he needed to buy as much as he could get his hands on.
I’m throwing rocks in a glass house here, as I got into dividend stocks in mid May last year, and as soon as there was a dip I bought a bunch more on margin (I thought I was being conservative, but I got hit with 2 small margin calls).
If anything, chances are good that if you learn about a new investment strategy, it’s probably been doing well recently (given that people are writing or talking about it and advocating / teaching new investors about it). From just a reversion-to-mean perspective, it’s probably LESS LIKELY to do well in the near future, BECAUSE it’s been doing well recently (like real estate and dividend stocks right now). Perhaps the best investment strategy would be to read 10 year old “get rich quick” books and copies of the Wall Street Journal? 😉
I’ve seen the pattern repeatedly where people learn about a new strategy, think it’s great, then bet the farm on it before they’re knowledgeable enough to really assess the risk / reward trade-off being offered. Cooler heads wrote early on that the bank stocks were probably going to keep falling, and I could have saved myself thousands of dollars if I had waited a few more months to buy.
My fear was that I’d miss the dip and be kicking myself for not buying when they were higher.
I’m not sure if this is a general problem for anyone learning a new strategy, or just an issue for certain personality types. The rational approach would obviously be to start small with a new investment strategy, test the waters, and gradually increase your investment as you learn more. People (in my experience) don’t do this, and seem to fall into two camps: either they don’t invest at all (all money sits in GICs and savings accounts), or they seem to over-invest early in their self-education.
Do you think putting too much money in an investment while you’re still a novice is a common investor problem, or do you think Mr. Cheap is just trying to project his issues on the rest of the investment community?
13 replies on “Early Excitement in New Investments”
Perhaps the best investment strategy would be to read 10 year old ?get rich quick? books and copies of the Wall Street Journal?
You know – that’s a really great idea!
I think you are exactly right – new investors always get too excited about things. Kind of like first time home buyers.
Mike
I think you are right. It can be like drugs- you keep wanting to maintain the high so you keep plowing money into something you truly don’t understand.
People tune out when you tell them to be patient. Our minds don’t work that way.
I think that if someone believes that have a good investment strategy and has done enough research to make themselves confident in it (and has the appropriate risk tolerance), they should dive in. It’s all about risk and reward.
Take me for example… I just took an 80k loan to invest in BMO. I think it’s a good idea and I think the dividend is safe and it’s a good long term buy…. But I know most people couldn’t handle that.
But, I also know the worst case – the bank fails and I owe 80k, I’m willing to live with that 🙂
Perhaps the best investment strategy would be to read 10 year old ?get rich quick? books and copies of the Wall Street Journal?
I’ve had an idea for a blog post for several months, since I picked up a copy of 1993’s Growth Stocks for the 1990’s for 10 cents at a used bookstore last year.
My idea was to read it, “review” it and use it as a sort of lesson for why we need to take investment books with a grain of salt as they’re most likely greenlighted because the investment they champion was popular at the time, but the more I think about it, the more there’s probably some wisdom to it.
The most recent example I can think of is energy. Anyone who had the fortitude to gobble up Exxon, Encana, Shell, BP, Suncor or Petrocan in the early 2000s when oil was under $20 has done quite well.
If you’re a member of the resources, real estate and the BRIC economies choir in need of being preached to, head over to your local bookstore.
A better use of my time and resources might be to invent a time machine.
When buying stocks it is always a good idea to buy in stages. If your conservative buy ? at a time over 6 Months. Especially if the stocks have been heading down as I assume the bank stocks were doing when you bought. If you?re more aggressive I would suggest sliding scales where you buy more as it goes down thus lowering your cost basis even more (I set my scales at 20%, 20%, 15%). This means if the stock drops 20% buy 2 times the original purchase, down 20% buy, down 15% buy. I have been doing this with Citi lately. I bought 50 shares at 30, 100 at 24, and 200 at 19.2 making my cost basis around 22.11. Right now I have a small gain from the investment. If I had bought all at 30 when I first got interested I would be sitting on a large loss.
Two things to keep in mind when doing this. One, make sure you have the stomach for it. It is easy to lose your nerve and not pull the trigger when the stock is in freefall which tends to happen when a stock bottoms. Two, make sure that you have done your research and this is a dip in the stock not the first leg in the path to 0. What I do is write down my thesis as to why a stock is a good buy. Do your research around each buy point to ensure that that your original thesis is still valid, but don?t get caught up in the hype of the moment. With Citi for instance I wrote that the stock was oversold due to residential real-estate weakness and the coming write downs. There was a ton of negative news at each buy point (and will be much more), but all this was known when I started researching the stock at 30. Nothing had changed it was just being reported over and over again (hype). What would make me change my mind about Citi? If commercial real-estate tanks on the scale of residential, I would admit that my original thesis was wrong and sell. That?s why you write it down. It is easy to convince yourself that you knew of all the issues when you bought, but if you write them down you will own up to the fact that you were wrong earlier and save yourself a lot of money.
Finally, a couple of observations from your post:
One, you bought on margin. I never do this because you lose control over your investments. You may be forced to sell to meet a margin call at the absolute worst time. I suspect that this is one of the reasons for steep declines in stocks near bottoms.
Two, you mentioned dividend stock investing and then talked about bank stocks which are traditionally stocks in this category but do not fit this model at present. The key to dividend investing is that the dividend is safe, and growing steadily (Thus conservative). Banks dividends are anything but that right now. Banks are a distressed asset (Deep Value) play right now and have been all year. While distressed assets can make you tons of money they are far from conservative. If you are going to buy distressed assets you must be willing and able to keep a very close eye on them. These assets are distressed for a reason; a lot of smart people feel there is a real problem in them. The minute you start thinking you are smarter than the market you are doomed to fail. Remember your risk reward relationship, anytime you think you have found an investment that breaks this rule you are fooling yourself.
DM – you are a brave soul. The problem is – what if BMO isn’t a good investment?
GIV – I can’t believe you found that book at ANY used bookstore. That’s like buying a Windows 3.1 manual… 🙂
Let us know about the time machine.
Mike
I think Mr Cheap is just projecting.
Of course, I don’t really, but I am hoping that my evangelical zeal for broadly diversified index funds won’t turn out to be a lemon.
Plonkee – you CAN’T go wrong with index funds. I (almost) guarantee it!
Mike
FP: Of course it could be a bad investment, but I don’t think it’s likely – to the tune of 80k 🙂 And I hope by brave you don’t mean stupid 🙂
Tom: All of your points are great ones. But I don’t agree with buying in stages as a rule for me. The reason why I think it’s a good rule for most people is because people feel a lot worse with losses than they feel good with gains and have a tendency to bail on good companies (even on indices) when things go sour. I believe this is Mr. Cheap’s point in the post as well.
Of course, I don’t suggest what I’m doing to anybody – it works for me because I’m comfortable with the risk.
But I would be surprised if BMO, 20 years from now, is languishing or has collapsed, I’m young, I think that’s the best time to take the risks and I don’t plan on selling – I have lots of time to recover from big mistakes 🙂
Maybe I should start a blog.. the crazy investor.
do you think Mr. Cheap is just trying to project his issues on the rest of the investment community?
No, you’re doing what everyone does 🙂
Honestly cheap, basically all investments are some form of zero-sum game. Which means that money goes from the bait to the sharks.
If you read Rich Dad, Poor Dad and used that as inspiration to start plowing money into real estate, you’re a fish. If your plan is to make money by doing the same thing that everyone else is doing, then history is not on your side. You’re a fish. If you think that some existing, established market is not efficient and that you will be victorious b/c you read some bad book, you’re a fish.
The rules haven’t changed. If you’re doing what “everyone else is doing”, it’s quite likely that you’re too late. Are you the 10th person on your block to: join Amway, invest in real estate, collect beanie babies, buy cheap dividend stocks, collect tulip bulbs…?
“Joining the club” doesn’t have a great history of financial success.
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Dividend Man
The reason buying in stages is good is that it lowers your cost basis in any given position. Buying all at once is arrogant. You are basically saying that you are smarter than the market and know the precise time and price at which to buy. I did this a lot when I was young, but over time realized that more often than not I could have gotten a better price if I had been patient and set up a plan to buy in sliding scales. The major argument against it that I get all the time is: What if the stock goes up and never gets to your next buy point. The answer to that is simple: Move on and buy something else. There are tons of good ideas out there at any given time; the thing that is in limited supply is the money you have to invest in them. start your next position just like the last one. If you find time and time again that everything you buy is at a bottom and you would do better not using this method, then by all means abandon it (and consider managing a mutual fund or hedge fund because you are either very smart or very lucky).
What you are doing with BMO I have seen many times in the past. You basically use the dividend payment to pay the interest expense on the loan thus gaining control of the stock for no apparent cost. Nothing in life is free. The cost is risk.
There are two major risks to this strategy:
1) The dividend gets cut ? You say that you have researched this and feel comfortable with the current dividend. For the first quarter BMO earned 255 million and paid out 365 million in dividends (That?s a 143% payout ratio). BMO needs to reverse this trend quickly or they will cut their dividend (especially since it is so high that they can cut and still offer a good yield 6.2% is over twice the 5 year average yield for this Bank).
2) Your cost of borrowing goes up while the dividend remains the same thus costing you money to hold the position. You say that this is a long term investment. You better have a plan for when short term rates go up, which they inevitably will at some point in the future. With short term rates near historical Lows and inflation raging in energy and food, rates will likely rise over the next 5-10 years.
I am not saying you will not make money off of your speculative play here, I am saying it is VERY RISKY and I hope you understand all the risks before you bet your financial future on this single play.
I?m curios, what price did you pay for BMO?
I thoroughly enjoyed the article FP. The thing that you are refering to in it is called a recency phenomenon. Investors are always excited about the stuff that has recently made made to a small number of fortunate investors. People start bidding those assets up, and then most of them lose money and say to themselves never again to touch that thing.. Next thing you know, these same investors are buying the next big thing..
I believe that in order to be a successful investor you need to :
– diversify accross industries, strategies, asset types, countries, you name it
– buy your assets over time/ most employees do that/
– try to invest in index funds as opposed to some active 4.5% load, 2% annual expense hot fund
– Do not leverage yourself more than 100%. If you have $1000 ready to invest, do not take more than $1000 in leverage.
– Buy things you know.