Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re an aggressive or a conservative investor, these weekly updates are designed to give you specific investment advice. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.

Today’s tip: “Why you should be wary of ‘investor rules’”

Most investor sayings or rules have some truth, logic or value to them. That’s why investors keep repeating them. However, their truth or logic may be irrelevant to your investment goals, particularly if you are a conservative investor.

Conservative investor: How investor rules can kill your profits

The value of investor rules or sayings may be psychological rather than financial. However, there is always a risk that they could override your best judgment at precisely the wrong moments, and lead you to do things that undermine your investment success.

Here’s an example of one investor rule you may have heard with stocks that have moved up since the market lows of March 2009: “You never go broke taking a profit.”

This is true only in an extremely narrow sense. The act of “taking a profit” (or selling an investment at a higher price than you paid for it) won’t, in itself, put you into bankruptcy. However, investing would be easy if all you had to do was avoid going broke.

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In our view, your goal, particularly if you’re a conservative investor, is to make an attractive return on your investments over a period of years or decades. Failure means making bad investments that leave you with meagre profits or losses.

Unsuccessful investors can still make some profits. They just don’t make enough to offset the inevitable losses and leave themselves with an attractive return. If you focus on the idea that you never go broke taking a profit, you may be tempted to sell your best investments whenever it seems the investment outlook is clouding over.

On occasion, you may succeed in selling just prior to a major downturn, and buying back at much lower prices. More often, prices will soon hit bottom and begin to rise. If you buy back, you’ll pay higher prices.

Our investment advice: No one can consistently predict market downturns. In hindsight, market downturns are easy to spot. Spotting them ahead of time is much harder, and impossible to do consistently. After all, if you could consistently spot market downturns ahead of time, you could acquire a large proportion of all the money in the world, and nobody ever does that.

That problem is that you’ll foresee a lot of market downturns that never occur. All too often, the market-downturn clouds disperse soon after skittish investors have sold. Good reasons to sell do crop up from time to time, of course, even if you’re a conservative investor who invests for the long term. But “you never go broke taking a profit” is not one of them.

Next Wednesday, June 8, 2011, Investor Toolkit will look at the dangers of investing in stock options.

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