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5 Steps to Better Investing

I think the time between Christmas and New Year is one of the best times of the year.

When I’m on holidays, this week is a great time to put my feet up, catch up on some reading, and reflect on the year just gone and the year ahead. If I’m working, it’s usually a pretty laid back time; a good chance to take advantage of light traffic and an almost empty office to catch up on work and get ready for the year ahead.

A Happy New Year
With less on our minds and the calendar about to tick over to another year, our thoughts also turn to resolutions, or at least to those things we want to do differently, come 2012.

With that in mind, The Motley Fool is bringing you a 5 part series we’re calling ‘5 Steps to Better Investing’. We’ll cover 5 topical issues that we hope will help you make better investing decisions in 2012.

Step 1: You don’t have to make it back the way you lose it
We’re only human – and prone to the psychological challenges that come with the territory. Chief among them is an over-reliance on the immediate past, and the tendency to extrapolate the most recent past into the future. For many, that has meant a 2011 that went from bad to worse – and felt terrible.

Our human nature also puts unnecessary constraints on our investing. When a stock we own has fallen below our purchase price – or if we’ve made some money, has fallen from a recent high – we can tend to fixate on making that price a ‘target price’ of sorts. Whether we’ve made or lost money on that particular company, the risk is still the same.

When we invest, it should be the company and its prospects that are important. No previous price – or future hoped-for price – is meaningful for the company itself, nor for the company’s customers or suppliers.

Let bygones be bygones
Our tendency to hold on to a company’s shares ‘until the price goes back up’ is exposed as an understandable, but erroneous errand.

As investors in Billabong (ASX: BBG), Myer (ASX:MYR) and JB Hi-Fi (ASX: JBH) know, prices can fall precipitously when a company releases bad news to the markets. Once the price has fallen, however, investors need to put that loss to one side.

Painful and difficult, yes, but also very necessary.

The Motley Fool has long encouraged investing for the long term, with holding periods ideally measured in years rather than weeks or months, but we also know that vigilance is required. If your reason for investing in a company still holds true, and a company remains valuable despite the bad news, it might be time to hold, or even to buy more. If the investing thesis has been undermined by recent events, it may be time to sell.

Invest in your best ideas
With limited funds, an investment decision is no different from a weekly budgeting decision – investing in one stock means those funds can’t be used for a different decision.

If I believe Company A has better combination of business economics, growth potential, management expertise and share price than Company B, I should buy shares of Company A (all else being equal, and taxes notwithstanding).  I don’t expect I’d get much argument from anyone on that point.

Accepting that premise is one thing, but acting on it can be very different – especially when you already own one of the companies.

There is unfortunately no shortage of companies trading well below their January 1, 2011 share prices. Some are trading near two or three year lows. Others have had a stunning run over the past few years.

Reassess and take action
If you have shares in the former group, I would strongly encourage you to not hold those shares simply because you’re sitting on a loss and you’re planning to wait until the price recovers. Equally, if you’ve had a good run, don’t sell simply because the price is up, or hold for the same reason.

Instead, subject your holdings – and prospective holdings – to the Company A vs. Company B test.

If the companies you hold are the best place for your money on that basis, you should consider holding with confidence. If they fail, holding on to them while you wait – perhaps in vain – for the price to recover, simply consigns your portfolio to continued underperformance.

Foolish take-away
The New Year gives us all a chance to reset our investing scorecard. I’m not suggesting that ignoring the past is a good strategy – far from it. Experience – even years like 2011 – is an important part of successful investing. Trying to divine success from periods as short as a single year will lead to a multitude of errors.

That said, the opportunity to mentally reset – to put the year just gone behind us – can act as a psychological circuit breaker. It’s why many of us use January 1st as a starting point for New Year’s resolutions.

As you enter 2012, remember to look at your portfolio with fresh eyes – and resist the temptation to stubbornly hold on to a stock just because ‘it owes you money’.

Are you looking for quality stock ideas? Readers can click here to request a new free report titled The Motley Fool’s Top Stock For 2012.

Scott Phillips  is The Motley Fool’s  feature columnist. The Motley Fool’s purpose is to educate, amuse and enrich investors.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson

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