Three Common Misconceptions about Investing

To avoid falling into the mainstream traps of conventional wisdom, here are three fundamentally different ways to think about investing that which is most precious: your hard earned money.

Higher risk does not always equal higher return

Simply taking more risk because it promises higher returns is foolish and will almost certainly lead to losses over time. Instead, the best investors view risk differently. They define risk as the probability of a permanent loss of capital. In their world, investing is about minimizing losses, rather than maximizing gains. When making an investment decision, they do everything in their power to ensure that they will not lose a single penny of the money that they are committing to an idea. As a principle, this does not mean buying low-risk assets like government bonds. Instead, it means:

Buying shares of wonderful businesses;

That trade at a fraction of what they are truly worth in the long run.

Where the price you are being asked to pay today is so low,

That you do not risk losing money.

For us mere mortals, this is the only proven strategy that we have come across that is a) easy to understand; b) anyone is capable of implementing; c) requires relatively little long-term effort; and d) protects you from inflation. To properly employ this strategy, it is crucial that you have the mental fortitude to withstand swings in the share price – daily, monthly, and yearly. Furthermore, you must have a long-term orientation. The money that you invest in a wonderful business can be tied up for decades and it should be in order to maximize the value of compound interest.

The price that you pay when you buy a business determines the level of risk you take and the return that you can potentially earn. Pay the lowest price.

It is not an understatement to say: the price that you pay for a business is everything when it comes to investing. Pay too much and you will most definitely never see the full value that you invested again. Pay a bargain price consistently and it will be difficult to lose money, even if the future is not as rosey as you may have initially thought. Understanding this fundamentally is great, however it is certainly more easily said than done when it comes to investing real money in real life. When buying stocks, we tend to employ the following technique, which we have learned from industry professionals over the years.

When you see a business that you are interested in, but you are unsure if the price is low enough to insulate you from potential future declines, sit on your hands and wait. After time passes and you see that the price has declined further and you desperately now want to buy, DO NOT DO IT. When the price is so low that every fiber in your being is screaming at you to buy shares because the price cannot get any lower, HOLD OFF and wait some more. Finally, when the price is abysmally low, take your first position, but do not invest every dollar that you plan to commit to the business all at once. Go slow and dollar cost average into the business over time. This is the only way to consistently ensure that you do not pay a price that looked attractive in the moment but appeared utterly foolish in hindsight.

Price and value are fundamentally different. Do not confuse the two.

The stock ticker you see flashing across your computer screen is the price that you are being asked to pay on any given day. The value of the underlying business is something completely different, which is 100% subjective in nature. Everybody will have differing opinions and methods for assessing its underlying value. Only those who profit are proven correct in the end. To properly determine a company’s value it is crucial that you view its stock as fractional ownership of the underlying business. You are buying a small piece of something that creates value, sharing in profits and suffering from misfortunes. After working your day job and collecting your paycheck, would you invest a large portion of it into a business, without knowing if a) it was earning any money; b) being run by a shrewd and competent team of managers; or c) built to exist and thrive over the next three, five, or ten years? We certainly wouldn’t.