One of Charlie Munger’s favorite pieces of advice is to always invert. Let’s apply his advice and start by answering the following question: What is the most certain way to lose the most money investing in stocks?
What is the most certain way to lose the most money investing in stocks?
1. Invest in Bad Businesses: Pick businesses in tough, unpredictable industries with rapid change. Make sure they also lack any competitive advantage.
How this helps you lose money: Investing in businesses that are both subject to rapid change and lack a competitive advantage increases the odds that the business is likely to be a lot less profitable in the future.
2. Invest with Bad Management Teams: Look for management teams that are trying to make money off of you as opposed to with you, and are skilled at transferring wealth from shareholders to themselves. Lacking any of those, look for teams that are demonstrably bad at both operations and capital allocation.
How this helps you lose money: Just in case the business managed to make some profits despite your best effort at selecting a bad business, this helps to ensure that the profits will either go to the management team or be squandered by it rather than end up in your pocket.
3. Invest in Companies with Too Much Debt: Find companies that have so much debt that any adverse development is likely to cause financial distress.
How this helps you lose money: On the off chance that the management team you carefully chose for its avarice and incompetence left you some money, having too much debt will make it likely that that money will go into the pockets of creditors rather than your own.
4. Pay Too High a Price: Make sure to pay way more than the intrinsic value of the business.
How this helps you lose money: If despite your best efforts some money made its way from the business to you, its owner, this will help you to make sure that your rate of return will still be low.
5. Focus Only on the Short-Term: Don’t think about long-term economics, just focus on short-term trading considerations. (For more on this topic, see How and Why to Be a Long-Term Investor.)
How this helps you lose money: Shares more of the little money you have managed to get out of your investment with your broker and tax collector.
These are five of the biggest mistakes investors make in the stock market. As Charlie Munger likes to say “Tell me where I will die so that I never go there” – avoid all of the above mistakes, and it will be a lot harder to do poorly at investing.