Monday, November 17, 2008

Boomer's Wake Rule #1 - Do not follow the herd!

Boomer’s Wake Rule #1 - Do not follow the herd!
I remember back in the ‘90s when I wanted to invest in what turned out to be one of the strongest markets we have ever seen. It was frustrating that I just didn’t have the money to invest. I was only in my 20’s and they were in their 30’s and 40’s already and obviously had a huge head start. By the time I started making enough to invest, it was right at the peak in 1999. I was following the herd and got killed in the process.

Don’t chase winners
Chasing winners means that you notice that an investment has been up a lot over the past year. You feel like you are missing out on something so you get in on the investment late in the game. How do you know it's late? Unfortunately, when you finally hear about some idea and finally feel comfortable dipping your toe in the water, the time it took you to validate the investment was the prime time for the investment.

The key to investing in momentum investments and bubbles is that there must be a larger base of people buying after you. If your friends, the cab driver and your aunt Edna are all talking about what a great investment something is, chances are you are chasing a winner and will be among the last to buy before it starts to go down.

Beware of “hot tips”
People who already own investments love to give tips. But think about it! They want others to buy what they own to justify their position and ultimately to have others to sell to. You need to clearly understand the motivation of those giving the tips. Is it your uncle who works in insurance but telling you about webvan.com? Or is it your friend who works for Apple and just got a chance to see this new thing called the iPod?

Do the opposite at euphoric and pessimistic extremes
We have had the luxury of witnessing at least 4 or 5 major extremes in the past 8 years in various markets. We need to remember these times and learn from them. Remember the Dot Com euphoria? How about post 9/11 pessimism? Housing? Oil? We need to become fearful when everyone is euphoric and euphoric when everyone is fearful.

If you look at a stock chart over time, you can easily see that when everyone was euphoric about Dot Com, it was exactly at the top of the market. Boomer's Wake investors need to ride with the masses during the middle of the trend, but never be afraid to sell near tops, even if we think we will miss more gains. Holding out for that last 25% may cost you 50% or 75% of your money!

Understand macro-economic trends and micro-economic swings
It is very important to understand that marco-economic trends (those lasting many years or even a decades) have many micro-economic swings within them. In fact, when something with a strong macro-economic trend has a micro swing in the opposite direction, it is a great time to invest.

For example, we know there will be a shortage of energy on the planet for the next 10-20 years while we work on alternative energy. But we happen to be in a recession, causing the short term demand to diminish temporarily. If we believe the macro-economic trend is still in place, we should jump on the chance to invest while the market is thinking in such a short-sighted way.

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