Wall Street Wizard Or Investing Idiot? How Not To Be A Stock Market Patsy

“If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.” -Warren Buffett

In case you don’t know what a patsy is, it’s a person who is easily manipulated, taken advantage of, or deceived. In other words, the person is a sucker. No surprise then, that the word patsy is derived from the Italian word pazzo, meaning fool or crazy person.

And there’s no better place to find thousands of foolish people, doing crazy things with their money, than in the stock market. Indeed, the stock market is full of patsies.

Want proof? Here you go:

The average return on the stock market for decades and decades is about 10%. Sure, the market has it’s ups and down, swings and swoons, but over time it’s returned about 10% on average.

Now, here’s the interesting part…

What would you think is the average individual investor’s return over those same decades and decades? Ten percent? Not even close. Seven percent? Hardly. Five percent? Wishful thinking.

The average individual investor’s return is a paltry 3%.

That’s 70% lower than the average return of the market. Put another way, if the average investor would have just put their money in the market and left it alone, their returns would be more than double what they normally generate.

A blind monkey could do better than the average investor

Put even more starkly, a blind monkey who accidentally hits a computer button once to invest his money in the market and then happily goes about life eating bananas and swinging on tree vines, never to touch his investments again, will do seventy percent better than the average investor.

Gulp.

If that sobering statistic doesn’t make you want to learn to be better investor, then you shouldn’t be investing in the stock market.

So, why does this happen? Why does the average investor do so poorly in the market? It’s because they are they patsy at the table. They let their emotions get the best of them and do the complete opposite of what it takes to be successful in the stock market.

So who is the patsy at the investment table? You are, if you:

Think making money is the first priority in investing. In gambling there’s an old canard about betting: If you don’t bet, you can’t win. I have a different philosophy: If you lose all your chips you can’t bet and then you go home a loser. Each day, thousands of glitter-eyed investors enter the market with fantasies of getting rich quick off of a single trade. Without thinking of the consequences or having an investment plan, they wager their hard-earned money on speculation and hope. And what usually happens is that their hard-earned money is soon transferred to someone who does have an investment plan. You see, when making money in the market is your top priority, you’re much more likely to make the all-too-common mistake of reaching – taking on risky, haphazard investments that almost always lose money. And for every dollar the patsy loses, they have to earn a 100% return on their money, just to get back even. How many people do you know that consistently earn 100% on their money? Exactly none. If you would like an example of the fallacy of “making money” as an investment priority, read-up on the history of Long-Term Capital Management. This company lost $5 billion in just 6 months by having “making money” as their priority in investing. Know this, the first priority of investing is the preservation of capital. Indeed, Buffett’s rules of investing (Rule #1: Never lose money. Rule #2: Never forget Rule #1) are the foundation of investing. Invest wisely and cautiously and with an eye towards protecting the downside, and the upside will take care of itself. It’s much easier to stay out of trouble now than to get out of trouble later.

Try to time the market. Warren Buffett has stated over and over that he cannot predict what the stock market will do tomorrow. And if the world’s greatest investor can’t, you can’t either. It’s simply a fool’s errand to try to predict the future of stock prices. Yet, so many try and usually end-up becoming a stock market patsy by losing all their money. You see, the patsy makes their decision based on some imagined trend, usually amplified by what some talking head on TV says or worse, from “signals” provided to them by some expensive software that guarantees to get them in and out of the market at just the right time…until it doesn’t. If being successful with investing was as easy as using software or trends to dance in and out of the market at just the right time, then everyone would do it. Successful investors don’t try to time to the market. Rather, they have an investment plan that is independent of the market’s short-term mood swings and is based on sound judgement for determining when a stock is undervalued or expensive. In short, they don’t “listen to the market”. Rather, they listen to their investment philosophy, which gives them the patience and wisdom to do the opposite of the stock market patsy and succeed with investing.

Don’t do your own homework. Although individual investors are capable of doing their own research, including going through company financial statements, looking at price to earnings ratios and comparing companies across a sector, many don’t do the work. Rather, they rely on an investment adviser or money manager to make decisions for them. They simply outsource some of the most important decisions in their life (what to do with their money) to someone else. As Jim Rohn used to say, “If you don’t have your own plan, then you’ll be part of someone else’s plan. And guess what they have planned for you? Not much!” For individual investors, the best method is to treat financial analysts and advisers the same way your treat a rear view mirror in a car – trust, but verify. Other people’s research is, even at its best, just an informed opinion. At its worst, it’s corrupted by their own bad thinking and market biases. The successful investor does their own homework. As Buffett always says, “my idea of a group decision is to stand in front of the mirror.” You need to decide and must live with your decisions. Before investing on your own, ask yourself whether you are able to interpret and understand financial information, have enough time to manage a portfolio, and will spend the time necessary to do the work required of sound investing. If you’re not sure, then don’t invest.

Jump on the latest red hot stock. Everyone is a-buzz about that latest technology stock that’s supposed to be the next Google or that soon-to-be FDA approved drug from that nascent pharmaceutical company, so these must be good investments, right? No. That’s the thinking of the stock market patsy who believes that just because a stock’s price has been bid up lately, that it’s a good investment. Jumping into a skyrocketing stock without any foresight is akin to an impulse buy at the grocery store checkout counter – grabbing that Snickers bar doesn’t fit with your diet plan, but it ends up in the shopping cart. It also generates the same response – indigestion. Instead of buying the latest hot stock promoted in the financial news, or worse, on a tip from a friend or co-worker, the successful investor frames the question of whether to buy a stock in relation to their overarching investment strategy. This tempers the impulse to buy on emotion and allows them to view their stock purchases more rationally. To avoid being a patsy, ask yourself, “Does this stock meet the criteria I’ve established for myself within the guidelines of my investment plan?” If not, move on and stay true to your plan. In other words, leave the thrill rides to the amusement park.

Patsy investors are often portrayed as the “dumb money” in markets, doomed to buy just before a crash and fatally drawn into buying fashionable stocks at just the wrong time. Don’t be the dumb money in the market. Wise-up on investing and spend an inordinate amount of time learning about successful investing before you put one dollar in the market. Avoid the common investing mistakes mentioned above and you’ll avoid being the patsy at the investment table.

Be free. Nothing else is worth it.