“You don’t know what you’re talking about,” is the most valuable piece of advice any investor can use in the stock market. I learned this while working for an online brokerage company. The information overload I experienced  while working there was intimidating, overwhelming, frustrating, understandable, illuminating, and intoxicating. I thought I knew something when I finished working there, and I was eager to put that knowledge into play in the market. Every time I did, “You don’t know what you’re talking about,” became the refrain of my pain.

Watching the brokerage’s customers put their knowledge into play in the stock market only reinforced the idea that I didn’t know what I was doing, because they knew more than I did. Some of them could recite the company’s profit numbers dating decades back, they could explain cyclical trends in a company’s industry and they could convince me how these were indicators for future success. They were eternal optimists on the subject of their stock, yet their results ended up being as unimpressive as mine were. 

Some of these callers didn’t have the money to pursue their once-in-a-lifetime opportunity, some didn’t have the stomach to pull the trigger, and others didn’t have the brains as evidenced by the fact that they asked me for advice on what they should do. Those in the latter group were more memorable for the creative ways they tried to blame the company, and me, when their too-primed-to-fail moves fell through. The theme of these calls was, “You, and your company, shouldn’t have permitted me to do this.”

My lifestyle at the time was such that I provided friends the opportunity to use all of the clever and humorous variations of the word frugal. I had money at my disposal in the post-Reagan era that preceded the tech bubble bursting. Momentum, growth stocks were exploding all over the place, and the excitement from these gamblers (not investors, gamblers) was infectious. I forgot everything my grandpa and dad told me about investing, and I put my foot in the tide. I learned the hard way, that if I was going to make any money in the market, the last thing I should be counting on were my knowledge, or my knowledgeable instincts.

Invest in What you Know

“Invest in what you know,” the wizard of Wall Street, Warren Buffet, advised those of us who feel overwhelmed by the information required to invest in the stock market. The question I ask those who follow this wisdom is how often do your personal preferences align with the popularity of products?

An aficionado of coffee might know that the blend corporation ‘X’ puts together is superior to their competition, but do they really know that, or do they think that? More vital to the subject of personal investing is the question, does the coffee aficionado know anything about the business practices of ‘X’? They might know that ‘X’ makes a superior blend, because ‘X’ only uses the finest quality bean, but do they know how much that bean costs the company? Do they know what percentage of that cost the company passes onto the consumer? The idea that ‘X’ might charge the lowest possible cost possible to the consumer might be a key component to their personal loyalty to the brand, but how does this action affect ‘X’s profit margin? On another note, how many knowledgeable consumers have been frustrated by the number of consumers who for whatever reason, stubbornly insist on drinking what they consider an inferior blend? We might insist that our friends try our brand with the hope that they might switch, but how many of them do? They stubbornly insist on drinking their brand, because they’ve been drinking that coffee for years. It’s called brand loyalty, and brand loyalty can trump any definition of quality. Repeat after me, “I know nothing.” Buffet’s advice might be great for novices who have some money to play around in the market, and for them investing in ‘X’ is another way to show brand loyalty, but for serious investors seeking a path to some level of financial independence, it’s been a formula for failure in my experience.

Why do our employers provide us a select list of mutual funds for our 401k? They do it to protect us from indulging in our creative impulses. They know that the key to long-term investing involves slow growth, and they study the mutual funds market to determine which funds will produce long term and consistent growth.

“Investing doesn’t have to be boring,” I’ve heard creative investors say in response to the adage that if you find investing exciting, you’re probably doing it wrong. Creative investing involves an otherwise intelligent person finding creative end arounds to prove they are as skilled in the investing world as they are in their profession. Creative investors seek to impress their friends with exclamation points!!! They want to tell their friends that they were in on the ground floor of an idea that made them millions, they want to show their friends a physical product to “wow!” them, and they want their friends and family to talk about that investment that put them over the top in the arena of accumulated wealth. Any common Joe can invest in a slow growth, blue chip companies that has an extensive record of paying consistent dividends. Investments in those companies requires little to no creativity or ingenuity, and they are the antithesis of sexy, creative investing. Watching such companies plod onward with minuscule, but consistent profits is about as boring as the professions most common people have, but seasoned investors will say that that long-term boredom might provide the most probable route to long-term success.

On that note, a vital mindset that an investor should maintain is one that recognizes the continental divide between investing and gambling. Some seasoned investors might say that all investing is gambling. If that’s true, we maintain that there is a continental divide between gambling on an upstart and gambling on a blue chip stalwart that has a proven history of consistent returns. There’s nothing wrong with investing in momentum and growth stocks versus defensive stocks, but most momentum/growth stocks are more volatile than defensive stocks.

The difference between stalwart, blue chip stocks that some call defensive stocks and momentum, or growth stocks are often found in their volatility. A theoretical measurement of a stock’s volatility is the beta number. If a stock has a .44 beta number, for example, the investor knows that that company is theoretically less volatile than most of the stocks listed in the market, a .62 is a little more volatile, but not as theoretically volatile as most stocks. A 2.15 beta, on the other hand, is a number that suggests that that company’s stock is more volatile than the rest of the market. This number is a theoretical variable that suggests that a 1.0 stock moves in line with the market.

The opposite of investing in growth stocks that promise growth based on momentum are the defensive stocks that generally sell the staples of consumer related products. Defensive stocks generally provide more stable earnings when compared to growth stocks, and they generally provide consistent dividends to the investor, regardless what’s happening in the rest of the market. There is always going to be some volatility in a company’s stock, of course, but some would say that a blue chip, defensive stock that offers a dividend could be a better investment for a potential investor than a bank’s certificate of deposit (CD).

At this point, many of these companies offer a yield (dividend) that is better than what most banks can offer in the form of a CD, and taxes are lower on dividends from stocks than they are on interest from a CD. The one caveat on investing in a dividend paying stock is the prospect of losing some, or all, of the principle investment in the stock, whereas a bank enters into a locked in agreement on the principle, and the interest, with the consumer when providing a CD for a specified amount of time.

Some call blue chip companies the major players in their industry, or the household names. The Dow Jones Index lists thirty of the major players that have a propensity to either move with the market, or dictate the movement of the stocks in their industry, and the subsequent moves of the overall market over an unspecified amount of time. The stocks listed in the Dow Jones Index are blue chip stocks that generally offer slow growth and dividends to its investors. These investments are what a creative investor might call boring investments.

Be Boring 

I am not an investment advisor, and I don’t pretend to be one on this site, but when I talk about investing it inevitably leads some to ask me what particular investments I would advise they put their money in. I tell them that I wouldn’t be able to sleep at night thinking that they might purchase a stock I’m tracking, because I know how much their family is counting on them to make wise investments choices. My one piece of general advice is that they avoid creative or sexy investing and develop an investment strategy that involves getting boring. I tell my friend if he wants to up his income, his best economic opportunities available to him are at the office and in his work ethic and loyalty to the company, for that might result in raises and promotions. If he wants to get filthy, stinking, and “I hate you now because you have so much money” wealthy, the best route to accomplishing that is to have your money working for you. “Working for you” can mean a variety of different things to a variety of different people, but I would advise that an investor in an optimum situation that entails having some disposable cash on hand find the least volatile, blue chip company that pays a consistent dividend. If they are in this optimal situation where they don’t have immediate need for the money from those dividends, they should set up a Direct Reinvestment Plan (DRIP) on that stock to watch the slow growth accumulate over the long term.

Those readers who blanch at the notion that “You don’t know what you’re talking about” is solid investment advice, should know that it parallels the advice Warren Buffet gave elsewhere. “If you’ve got 150 IQ and you’re in my business, go sell 20 or 30 points to somebody else, ‘cause you really don’t need it,” he said. “You need emotional stability. You need to be able to detach yourself from fear or greed, when that prevails in the market. You’ve gotta be able to come to your own opinions and ignore other people. But you don’t need a lot of brains.”

I agree with everything Buffet says here, except for the idea that the novice investor should ignore the advice of others. I advised my friend to create a fake portfolio on one of the platforms that provide that function. I advised him to input data that suggests that he’s made a purchase of some shares at the amount of that day, and then chart that stock’s progress for however long he finds necessary, and read all of the data and analytical reports that his chosen platform provides. Then, allow some earnings quarters to go by and read, or watch, interpretations of the company’s quarterly report, and digest all of the negative and positive data provided. (The optimum is to read the company’s quarterly reports, but most of these are about as long as Ernest Hemingway’s Old Man and the Sea and about one-tenth as interesting.) If he is still uncomfortable with his knowledge regarding individual stocks he chose to fake invest in, I told him to delete the stocks in that fake portfolio and start charting mutual funds and index funds in it. Investing in these vehicles requires as much homework as investing in an individual stock, but some outlets like Morningstar.com provide comprehensive ratings on various mutual funds. They also provide a description of the risk the potential investor will experience if they ever decide to push the buy button, a full breakdown on the mutual funds’ investments, or asset allocation, and an outlook that ranges from one month to ten years.

Investing in mutual funds and index funds might be even more boring than investing in blue chip stocks, as it takes away the personal rewards investors seek when picking an individual stock and riding it to the top. If the investor is using the art of investing to prove their craftiness, I suggest that they might want to consider the far less expensive route of downloading one of the thousands of strategy and war games in app stores to satisfy this need. If they are seeking immediate returns on their money, just about every state now has craps tables and roulette wheels in their casinos that provide gamblers a guaranteed payout. For those who have worked hard for their money and now want their money working hard for them, it’s vital that the investor take stock of what they don’t know, as opposed to what they do, or what they think they do. For those people, “You don’t know what you’re talking about” is the best advice I’ve ever heard.