Thursday, May 23, 1996
Potholes on the Road to Foolishness
by MF Runkle

This past Sunday I hosted a chat room session about Foolishness on a Budget. In other words, how to invest if you only have a LITTLE money. A lot of excellent observations were made about the dumb things you can do as a small investor. I related to that because I've done most of them.

Frequent Trading---I did that when I was in my technical analysis phase. Trouble was, buying and selling stock all the time didn't get me much except killer commission expenses. Don't do it, I say, leave it to the big guys. Though I personally believe if you trade too frequently, the market will beat you no matter how big you are.

Variable Annuities---Life insurance salesmen seem to like these nowadays instead of whole life policies. They sell term + annuities. In concept, you pay no taxes on the earnings until you take the money out, which is after you retire. Since your income is likely to be lower then, you'll save with a lower tax rate. However, management fees are high, returns are often mediocre, and it costs money to pull out before a certain time (usually 5 years). So what you save in taxes can be lost in fees and lousy results. Dumber yet is to put your IRA into an annuity (I know, I did it)---I paid high fees, got lousy returns, and paid an arm and a leg to get out, when the investment was tax-deferred anyway. Ouch.

Penny Stocks---No. I know, your brother in-law knows a good company that is mining gold in Honduras. . . as I said, no. What? You know a company that is marketing chess on the Internet, traded on the Vancouver Exchange? Let me say this slower so you understand. . . nnnnoooo. Go to Las Vegas and bet on the roulette wheel. At least they give you free drinks while they take your money. But forget penny stocks. Even I have never been dumb enough to buy these (don't ask me about Las Vegas, though).

Small-cap growth stocks---Every beginning investor wants to get into the next Netscape or Iomega, and reap the resulting high returns. Doing so takes a bit of knowledge, and the ability to absorb some losses. So small caps are great when your portfolio gets larger, and when you have the time and knowledge to do your homework and really analyze them. My mistake was putting money into some riskier companies on a whim, and I lost more than I care to discuss (or want my wife to find out about). It decimated my portfolio.

Finance Seminars, most Newsletters, miscellaneous Financial Advisors---There are all kinds of people out there who want to take your money. What these people tell you, if it's worth anything (and most of it isn't) can be found in an hour on the Motley Fool, or in an afternoon at the local library. Check out the Fool's School, and go to the library and read Value Line. There are three books that I find indispensable, and you might, too: "Barron's Finance and Investment Handbook," "The "Motley Fool Investment Guide," and "Buying Stocks Without a Broker." Every Fool's library should have them.

Mutual Funds---These are founded on the premise that you're too stupid or lazy to invest for yourself. They give you the advantage of under-performing the market with diversification. I've met people who put their money into them because they "don't have time" to research investments. Well, if you don't have time to take care of your hard-earned cash, check out the Beating the Dow approach, or go with an index fund such as the Vanguard Index 500. At least it performs as well as the market, and beats 75% of other funds.

There are many pitfalls along the way to Foolishness for all of us. I've found most of them, and you can take my word for it. Of course if you don't believe me, try all the above (or just one), and then see if you don't agree.

Otherwise, be Foolish, and be glad it was me who was the fool.

Transmitted: 5/23/96