Here's How to Turn $1 Million into $450
For those of you keeping track at home, this represents a loss of 99.955%.
Why would anyone want to learn how to squander such money?
Well, three months ago I took the optimistic approach to investing when I detailed how you could turn $450 into $1 million. Today, I'm going to take advice from Charlie Munger -- vice chairman of Berkshire Hathaway -- and invert the process.
I'll show you how you could squander 99.955% of your money in hopes that you avoid the mistakes in your investing future.
A short history of value killers
There are tons of ways to lose money in the market -- some you have control over, others you don't. Let's focus on the former.
There are two big value killers that investors can and must avoid if they don't want to see their money disappear overnight.
1. Not understanding how a company does its business
If you can't explain how a company makes money to a kindergartner, you're probably better off avoiding the investment.
Just a few months ago at a campout, a friend asked me if he should buy Bank of America (NYS: BAC) stock. Having just finished Michael Lewis' The Big Short and done some background on the company's exposure to toxic mortgages, I asked him if he felt like he had a grasp on all of the company's assets and liabilities. He said "no."
Below are some tempting companies that I'll be avoiding because I just can't seem to wrap my head around all of their operations.
What They Do
Why I'm Avoiding Them
|Cheniere Energy Partners (ASE: CQP)||Owns liquid natural gas receiving terminal||I'm still uncertain as to whether fracking is used here, and if so, whether it's safe|
|Cheniere Energy (ASE: LNG)||Partner of CQP||See above|
|Renren (NYS: RENN)||"Facebook of China"||Government regulation, unsure of how it makes money|
Fellow Fool Dan Dzombak has already shown why Cheniere is a tempting play: Soon, natural gas will be exportable through a liquefaction process happening at companies like Cheniere. That's important because prices of natural gas are much higher in Europe and Asia than they are here.
So why am I staying away?
It all has to do with how the gas is extracted. I've been devoting a good chunk of my free time to researching what fracking is, and I'm still not 100% sure I'm on board. Preliminary results from a government task-force report released last week state that, "Gas fracking poses serious environmental risks."
Knowing that, I've decided that my best bet for natural gas is a tangential play: Westport Innovations (NAS: WPRT) , a company that engineers automobile engines that can run on natural gas. This business model is far easier for me to understand. You can read more about what I have to say about Westport here.
And when it comes to Renren, I'm in the dark. As sexy as it sounds to invest in the "Facebook of China," I can't say I have any idea how sticky the service is for Chinese users, nor am I fully up to speed on the ramifications of possible government interference on its business model.
2. Not having an exit plan
Even if you do have a good grip on how a company does business, if you don't have an exit plan in mind, you could be doomed to bleed your money away.
Don't believe me? Take a quick look at what Sirius XM (NAS: SIRI) investors have gone through over the past six years.
Back in December of 2005, the stock traded at $7.87 per share. But by February of 2009, it was down 99.3% to a measly $0.05 per share. Investors who didn't know what they were looking for in the company understandably bailed on their investment.
But if they did bail, they missed out on an incredible run, as the company didn't go out of business, but finally hit its stride, turning in profits in six of the last seven quarters. The stock climbed as high as $2.27 back in May, before settling down to $1.90 -- a gain of 3,700% from its low point!
Applied to your portfolio
One thing I hope you don't take away from this is that a company like Cheniere or Renren isn't a buy. I was offering up my own thought process for why I won't be buying; but if you're an expert in natural gas or Chinese stocks, they could be the perfect pick for you -- just make sure you have an exit strategy in place.
My goal was to shed a little light on how investors like you and me can avoid some common pitfalls and protect our portfolios from massive losses.
If you'd like one more idea for your portfolio, I'm willing to offer you access to The Motley Fool's hot-off-the-press special free report: The Hottest IPO of 2011. Inside, you'll find out about a fast-growing company that just about anyone could explain to a kindergartner. The report is yours today, absolutely free!
At the time this article was published Fool contributorBrian Stoffelis always looking for ways to avoid stupid mistakes. He owns shares of Berkshire Hathaway. You can follow him on Twitter at@TMFStoffel.The Motley Fool owns shares of American International Group and Berkshire Hathaway. The Fool owns shares of and has opened a short position on Bank of America.Motley Fool newsletter serviceshave recommended buying shares of Berkshire Hathaway and Westport Innovations. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.