5 Lessons on Investments
“I learned all five of them the hard way, and the first one was tough to swallow. And you?”
Lesson number 1: Stop Thinking You’re Smarter Than Others
In the world of finance, some of the brightest minds on the planet work tirelessly. Every day, countless trading systems and highly sophisticated econometric models are developed, backtested, and scrutinized by hundreds of Ph.D.s in economics, mathematics, and statistics, and even a few Nobel laureates. These individuals dedicate 8 or more hours each day with the aim of achieving superior returns over the long term. Yet, most of them fail.
This is where the lesson comes in: the market is complex, and success is elusive even for the best minds. This is why it’s crucial to stop thinking you’re smarter than others. Financial markets are counterintuitive, and arrogance often leads to mistakes. Remember, the more you think you’re superior, the more the market can punish you. It’s a hard lesson to accept, but it’s vital for any investor’s long-term success.
Lesson number 2: Forget Short-Term Gains and Focus on the Long Term
Everyone dreams of making money quickly, but financial markets are not the right place to fulfill that desire. The true power of investing comes from compound interest, which takes time to work its magic. If you rely on short-term trading, you’re likely to chase returns that are harder to come by.
What would be the misconception? Compound interest needs time to be effective. A 7-8% return annually over 20-30 years will generate significant capital, but trying to speed up that process by targeting monthly or weekly returns will likely lead to disappointment. Warren Buffett sums it up best: “The stock market is a device to transfer money from the impatient to the patient.”
Lesson number 3: Start Investing as Soon as Possible
The earlier you start investing, the more you can leverage the power of compound interest. However, this doesn’t mean rushing in without preparation. Before investing, it’s essential to understand key personal finance concepts such as:
• Investment intention
• Investment time horizon
• Risk tolerance
• How financial instruments work
You don’t need large sums of money to start; the Capital Accumulation Plan (CAP) is a simple way to begin. The key is to start now and make regular contributions, even if they’re small. Starting early allows you to harness the power of time.
Lesson number 4: Forget the Advice of Friends, Bank Managers, or Gurus
Unless you want to lose money, it’s best to ignore the advice of friends, bank managers, or gurus. No one can predict which stocks or sectors will thrive in the future. If you rely on someone’s stock tips, you’re essentially gambling with your future.
The truth is, most of these “experts” are more interested in their own financial interests or are simply lucky when they do offer correct advice. They might only highlight their past successes while forgetting their failed predictions. When someone offers you stock tips, remember: they’re probably not as well-informed as you think.
Lesson number 5: Backtesting is Not a Research Tool
Backtesting is essential for evaluating an investment strategy’s viability. It helps test hypotheses and refine strategies, including the impact of transaction fees or taxes. However, there’s a crucial caveat: backtesting should not be used as a tool for research.
Why? Because over-relying on backtesting can lead to overfitting – a situation where your strategy is too closely tailored to past data, losing its ability to predict future results. This leads to disastrous outcomes. As Cassie Kozyrkov, Chief Data Scientist at Google, puts it, “overfitting is the worst nightmare in machine learning.” When it comes to financial markets, an overfitted strategy can be a surefire way to lose money.
In conclusion, while backtesting can validate strategies, it shouldn’t be mistaken for a discovery tool. Always be cautious about using historical data to design your approach for the future, as what worked in the past doesn’t always work in the future.
Takeaways:
1. Humility is key in investing; the market will often remind you that you’re not smarter than others.
2. Focus on long-term growth, not short-term profits. The power of compound interest is realized over time.
3. The sooner you start investing, the better. Time is one of the most valuable assets you have.
4. Don’t follow the advice of others blindly. Build your own understanding and make informed decisions.
5. Backtesting is useful for validation but shouldn’t be the sole basis for strategy development. Avoid overfitting.
In the end, investing is a journey that requires patience, humility, and discipline. Take these lessons to heart, and you’ll be better equipped to navigate the unpredictable world of financial markets.