“There are men who gain from their wealth only the fear of losing it.” – Antoine Rivaroli (L’Esprit de Rivarol, 1808)

I’m not an expert in stocks, but I have been involved with stock-market publications and stock-market gurus for more than 25 years. During that time, I’ve met a lot of characters — some brilliant men without a trace of honesty and some honest men without a trace of intelligence.

I’ve seen investors swindled, bamboozled, conned, and just plain charmed. And I’ve been conned and swindled myself.

I have seen bright young men come into the market with brilliant new ideas and shine like stars — until their stars implode. I’ve seen crotchety old men who had been predicting a market change be proven right — after 20 years of being wrong.

I’ve known two-bit hustlers who would bully and scream at clients who even thought of asking for a refund and quietly confident brokers who spent most of their time trying to dissuade people from investing with them.

I’ve seen a lot — and though I have never attempted to figure out the stock market or how to get the better of it, I have developed an instinct for it. That may be too strong a way to put it. What I mean to say is that I now have a sense of what works and what doesn’t, which stories are true and which are not, and who can be trusted and who cannot — and I’ve been trying to assemble all this unarticulated sensitivity into some useful instruction, some of which I’ve talked about before.

Since I’ve had only meager success predicting the profitability of the businesses I’ve been in charge of all these years, it seems impossible for me to imagine that I (or anyone else) could possibly predict the future profits (not to even mention share prices) of companies that are remote.

That said, there is a very big market out there for just that kind of thing. There is a huge demand for expertise and an equally huge supply of experts. Of the many things you hear these experts say, two admonitions in particular make sense to me:

1. Don’t put too much money in any one recommendation.

2. Never invest in something just because you like the story.

The first principle is good because you never know, despite what you may think, the outcome of any particular stock or the market in general. By limiting each investment, you’ll never get so hurt that you won’t be able to keep going.

The second principle is good because a story, by its very nature, is meant to dramatize, not to inform. Professional salesmen know the value of a good story. There may be an ironic rule for this: the better the story, the less likely there will be a positive outcome.

There is one other investing habit that I’m inclined to call a mistake — though I have many good investment-expert friends who will tell me I’m wrong. That is the habit of leaving money in an investment after it turns south. My feeling is that when businesses start to fail, most of them, most of the time, continue in that direction. When it comes to investing in your own business, however, you can ignore this rule, because you can do something extraordinary to turn things around. But when it comes to other people’s businesses … well, you never know.

In past messages, we have spent a bit of time talking about how to avoid these mistakes:

* Make yourself a promise that you will never abandon your basic investing scheme to take advantage of a hot tip or an exciting story.

* Set trailing stop-losses (I recommend 25%) — and follow them.

* Limit each particular investment to 4% of your invested wealth. (I’d really like to say 1%, but, as JJF points out, “It’s hard enough to find 25 good investments … 100 is asking too much.” And, anyway, a 25% trailing stop at 4% limits your total risk to 1%.)

Today (while reading over some ETR comments on a recent stock recommendation that was sold to several of our readers), it occurred to me that each of these three mistakes is related to one or several emotional tendencies that are dangerous and destructive to long-term investing. Let’s take a look at them by asking a few questions.

1. Why would you abandon a sensible investment strategy to buy into a hot story?

* Greed. You know it violates everything you have learned about investing, but you’re willing to take a flier because the money sounds too good to pass up.

* Inexperience. It’s the first time you’ve fallen for a good story, so you don’t understand that good investments don’t always have good stories and good stories are usually just that — stories.

2. Why would you keep your money in an investment that goes down instead of up?

* Pride. You don’t want to admit you made a mistake. So long as you leave the money in the investment, you don’t have to admit you were wrong.

* Foolishness. The facts proved your theory wrong, but the broker tells you another story that promises a recovery and more profits. You’ve fallen for one story, and now you fall for another.

3. Why would you put too much money in one recommendation?

* Laziness. You want to make a big hit — and you don’t want to spend the time to research other possibilities.

* Weakness. The broker intimidates you into buying more than you want.

Think about your experience as an investor. Has it been less than satisfying? If so, what do you want to do about it? Here are two choices:

a. Blame your broker/adviser/fate.

b. Take responsibility.

If you are willing to take responsibility, you are going to have to make some changes in your behavior.

* Admit that you are not smart enough to always have the right stock. When the market proves you wrong by moving substantially against you (i.e., when you hit your stop-loss point), sell your position.

* Recognize that you don’t always have the right idea — and the same is true of your adviser(s). Stock pickers blow hot and cold. Even the best ones will be very wrong on a regular basis. If your investment system is sensible — no more than 4% invested in any one security and a strict 25% trailing stop — you won’t have to worry about believing the next good story.

* Train yourself to be reasonable in your expectations. The stock market returned, more or less, about 12% during the 20th century. If you’re happy with that, forget the whole system thing. Just buy an index fund with ultra-low expenses and you should come within 0.3% of the return of the market. But if you want to put yourself in the best possible position to do a little better than the market, follow the conservative strategy outlined above. (Keep in mind that even a 2% advantage, with compound interest, can mean up to double the wealth over time.)

Yes, you will lose money, sometimes, but it will never be so much or so often that you’ll have to worry about it.

As the years go by, you’ll get wealthier and wealthier. Not by a huge amount — that kind of growth will come only from your primary business — but by a percentage big enough to make you happy and comfortable when it comes time to slow down and rely more on your passive income.