If you don't know how to invest, then don't do it.

That's it. That's all you need to know. I wish there was a big secret to all of this investing. Something like: spend 5 hours a day sitting at your computer reading endless stories and documents about companies in the energy sector, call 3 brokers and see what they think, and then make your decision after the 3rd day of having talked to an investment professional. But there is no such investing secret.

If you don't know how to invest, don't do it. Of course, there is a cure for ignorance and that cure is knowledge. So, your only other option is to learn how to invest.

I've said it before and I'll say it again: invest in businesses you understand and know about. If you don't really know anything about any kind of business, then get out from under the rock you've been living under and take a look around. It really doesn't make a lot of sense for anyone to invest in companies that they don't understand.

I know a lot of folks who ask everyone and anyone for stock tips on what they should buy. Peter Lynch is considered to be one of the best investors in the world. Do you know what kinds of companies he invested in while he was running the show over at Fidelity? Taco Bell. Do you know why? He liked their tacos. No, seriously, that was a major consideration as so whether or not he bought their stock. Financial statements aside, the company has to sell something that makes sense, is in demand, and that has the potential to make money.

Usually, this involves selling something that has mass appeal. Would you buy it? Would your aunt Mildred? How about the normal, level-headed neighbors down the street? If the answer is yes, then it's time to check out the financial statements of the company.

It would be nice to think that buying into a company that was creating a cure for cancer would pay off handsomely. The truth is, it probably won't. Not unless it actually does it and sells the drug. But, there are so many hurdles before it gets to that point that it might be easier to buy a "Taco Bell" kind of company. It's simple. It's easy to understand. Whether or not what Taco Bell sells can be classified as "food" is debatable, but it apparently tastes good enough for lots and lots of people to eat there.

The same can be said for Dunkin Donuts. They have horrid customer service (in my experience), but have you ever had a cup of their coffee? It's amazing. I mean, for a donut shop. I've gone back to the 'ole DD again and again, not because I think the employees are the smartest or the kindest or the most attentive flowers in the basket, but because the company makes a damn fine iced coffee - and decaff at that!

How do you check the financial statements of a company? Don't make it too hard on yourself. Think about a business like you would think about an individual. If you had a friend that made $50,000 a year and had $250,000 in debts, and they were eying a new BMW while bragging about their recent vacation to the Cayman islands, and that they just drained their retirement account to pay for that vacation, would you say that made good or bad financial decisions? Bad? Why, how observant you are. Would you say that their financial picture looked rosy, or not so rosy? Not so rosy? Hmmm...you might be onto something there.

When you look at a business, pay attention to whether or not their business decisions make sense. Do they have a lot of debt that is being spent on projects that don't advance their core operations or core competencies (products and services that they understand and traditionally have done well with - think Starbucks and how their stock tanked when they started selling all sorts of non-coffee related products and went on a political campaign for socialized healthcare)? Have they made money consistently over the last 5 years? 10 years? How did they do during the last recession? Do they pay their managers fat bonuses and report quarterly losses? Do they pay their bills? Have they ever defaulted on a bond payment to their bondholders? What does their P/E ratio look like (most quoting engines tell you what the P/E ratio of a company is so that you can compare it with other companies in that industry). The lower the P/E ratio, the better value the company's stock represents.

Do some reading. Mosey down to Barnes and Noble or surf on over to amazon.com and pick up a copy of One Up On Wall Street by Peter Lynch.

Finally...don't worry about it too much if there is nothing to invest in right now. It's hard for some folks to think about life without the stock market. But, there are times when you simply have nothing-nothing that YOU know anything about-to invest in. That's OK. Eventually, you'll dig something up (provided you are looking) and you'll have the pleasure of knowing that even if you make or lose money, that you know why you made or lost money. And, that, dear friends, is a very valuable piece of knowledge to have.

You might also like

1. Why Socially Responsible Investing Is Irresponsible Investing
2. Saving Money Vs. Investing
3. Investing in Bonds……Fixed Bonds
4. Investing Secrets: Is Keeping All Your Eggs In One Basket Really Such A Bad Idea?

_________________________
This entry was posted on August 30th, 2009 by David C Lewis, RFC. Edits may have been made to keep this entry current. · No Comments · Investing