Over the last ten to twenty years, the financial environment, with the help of widely available technology, has slowly changed the the way people invest their money. A new style of investing (based on patience, discipline and risk management) is slowly replacing the cherry picking style of investing from yesteryear. Portfolios are now being built around diversification and an individual’s risk tolerance, time horizon and goals.
Slowly going away are the stock pickers who want to sell you on an investment as opposed to an investment strategy. Society seems to have accepted that investing as a ‘get rich scheme’ is close to dead. But the belief that instant wealth is possible still exists, and occasionally we come across water cooler talk when somebody has a hot 'stock tip' to share with whoever will listen. It’s human nature to want to hear the person. Even when deep down we know no investment is a sure thing, no matter how good it sounds.
Below are the seven most common water cooler investment tips and why I don't care for them.
The ‘I know a guy’ tip - The claim that a person has a connection to the guru of any particular specialty. In my opinion, this first entry is less of a tip and more of a braggadocios claim of having connections. The presenter of this tip wants the audience to believe they can get you in front of a person who will provide the golden goose and then take credit for the introduction. If this person is so good why haven’t we all already heard of him or her? It’s hard to keep the likes of Buffett or E.F. Hutton a secret. Moreover, there are also 'the guys' like Madoff whom a lot of people did know…but was obviously not a great thing. There is nothing wrong with an introduction to ‘the guy’, but be sure to do your own vetting.
The ‘This company is the next big thing’ tip – Predicting success for a company simply because it is involved with something deemed important or is part of a current fad. I hear this often when referring to fledgling alternative energy companies and internet ventures. While it is valuable for a company to produce something that has a demand/need from the public, the actual product is only one variable of a company’s success. If the company is managed or funded by fools then success is far from a guarantee. Pets.com, anyone?
The ‘My buddy made a killing’ tip – Encouraging someone to invest in a company because they know someone who got in at the right time and made a lot of money. First, I always have reserved doubt for someone who tells me they bought into a company at the bottom. The odds would be in my favor to call the person out, but I usually bite my tongue. But even if the tall tale is slightly true, how is this a good tip? Someone bought low, so it makes sense to buy on the high end? I’ll pass and instead try to find something else in order to be the subject of the next tall tale.
The ‘This investment has a guaranteed rate of return’ tip – Promoting the income producing side of an investment. This tip usually applies to investments that have an income stream (i.g real estate or stocks which pay a dividend), but I have heard references to many different types of investments. This might be the tip that makes me the most angry. Nothing related to investing is guaranteed. Sure, you can receive a defined income stream when you first get your money into an investment, but I have yet to see fine print that guarantees that the rate of return will never go down.
The ‘The price is so low it can only go up’ tip – Encouraging the purchase of an investment simply because the price is very low. This tip usually applies to penny stocks, but can refer to pretty much anything. To this I will simply say, until the price of an investment is zero, it most certainly can still go down.
The ‘I heard good things on the news’ tip – Promoting a investment because you heard a positive sound bite. This can also go the opposite way, recommending that you sell a holding because of bad news. This advice may be good for short term traders (and even then all news is suspect). For long term investing, daily sound bites are useless.
The ‘The market is overvalued and is about to crash’ tip – Encouraging a sale of all investments because the next big crash is around the corner. A close cousin of the ‘I heard it on the news’ tip, this is the ongoing proclamation that the sky is falling. There will always be people promoting the need to move out of something and into something else because the markets are ripe for a correction or bear market. I always stress two points in regard to this ‘tip’. First, 99% of these doomsday proclamations are a sales pitch for alternative investments. Second, given a long enough timeline, this prediction will eventually be accurate. However, given a short time line and this prediction will most likely be wrong. 'Experts' have been proclaiming the end of the current bull market for a least the past five years, while conveniently ignoring that we have already seen two market corrections during that time. There is an industry joke that goes, 'Financial experts have correctly predicted 15 of the last 4 bear markets'.
In my opinion, the best tips someone can give is to recommend diversification, investing for the long term and not allowing yourself to get greedy or emotional. But unfortunately that’s too boring a story to draw a crowd during water cooler breaks.