Investing is different from many other pursuits in one crucial way: doing the wrong thing as an investor can actually make money for you, but only temporarily. Buying low-quality stocks is a mistake that many investors make. Some get hooked on it, since low-quality stocks can be highly profitable over short periods. That’s because they are generally more volatile than the high-quality stocks (the kind that have a history of earnings, if not dividends) that we recommend in our Successful Investor newsletter.
Low-quality penny stocks are quick to fall when a bubble bursts
A decade ago, buyers of Internet start-ups made far more profit than investors who stuck with well-established companies. The same thing happened when many investors bought low-quality resource stocks in 2006 and 2007. However, when a bubble ends, prices of low-quality stocks inevitably come crashing down. After all, it’s much easier to launch a stock promotion than it is to create a successful, lasting business.
[ofie_ad] Penny stocks tend to be more speculative, and are engaged in such things as finding mineral deposits that can be mined at a profit, commercializing an unproven technology or launching new software. Because success in these endeavours is so rare, it’s all the more important to look for investment quality in your penny stocks.
The longer you play, the likelier you are to lose
If you lose money in speculative or other low-quality stocks (or funds that invest in low-quality stocks), you may think your main mistake was bad timing. That’s a misconception. You can get lucky in penny stocks, just as in lotteries. But if you play long enough, the “house odds” eventually triumph over any run of luck. In penny stocks or games of chance, the odds are against you. So, time works against you. The longer you play, the likelier you are to lose.
Two keys to long-term success
You can put the odds in your favour by following two simple rules: Invest mainly in well-established companies, and spread your money across the five main economic sectors (Manufacturing & Industry, Resources & Commodities, the Consumer sector, Finance and Utilities). You can do so directly, by selecting stocks from our recommendations in The Successful Investor, or by investing in funds that hold these types of stocks.
This puts time in your favour. The longer you stay invested, the more likely you are to come out ahead.
