If you’re a novice investor, it can be tough to know where to even begin. Between ETFs, mutual funds, stocks, bonds, options, and futures, there are thousands of choices for investors to sort through. But once you start, these 10 basic rules of investing can help you make smart choices when managing your investments. Think of it like buying a bottle of wine. Experts may be able to identify the best bottles by varietal and year, but novices are generally better off just looking at the Wine Spectator rating.
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The 10 Basic Rules of Investing Even the Legends Follow
The basic rules of investing don’t specify what ratios to use, or when to buy and sell. Instead, it’s about adopting the right mindset to find opportunity before the crowd and then positioning your investments for maximum success.
Investing legends like Warren Buffett, Benjamin Graham, and Sir John Templeton share several common traits:
- They have methodologies that make sense
- They are disciplined in their investment processes
- They work hard and stay focused
- They are patient
- They successfully handle their psychological biases.
Investors like Warren Buffett and Benjamin Graham embody these traits. They also follow some very simple formulas, which we’re distilling here as the 10 basic rules of investing.
- Follow Warren Buffett’s two rules. Buffett once said there were only two rules to follow with your investments: Rule #1: Don’t lose money. Rule #2: Don’t forget rule #1. Seems fair. We might add one more: make money. In truth, the rest of these rules just help you follow these three rules.
- Go against conventional wisdom. Attempt to be fearful when others are greedy and to be greedy only when others are fearful. Going against the crowd can be an effective way to make money.
- Look in the “wrong” place. Sir John Templeton once quipped, “People are always asking me where the outlook is good, but that’s the wrong question. The right question is: Where is the outlook most miserable? The obvious application of this concept in practice is to avoid following the crowd.”
- Look for the overlooked opportunities. To quote Joel Greenblatt, “Companies that are too small for professionals to buy and that are not large enough to generate sufficient commission revenue to justify analyst coverage are more likely to be ignored or misunderstood. As a result, they are more likely to present opportunities to find bargain-priced stocks.”
- Buy companies at bargain prices. Look for solid return on equity, high operating margins and low debt. In addition, look for companies that generate lots of cash and have a consistent operating history during the past 10 years.
- Stick with what you know. Stay within your circle of confidence. If you don’t understand what a company does or how it makes money, avoid it.
- Hold your stocks. Many investors forget that the way you make money in the stock market is by holding stocks, not buying or selling them. Sounds obvious, doesn’t it? That’s just how the stock market works. The value of your portfolio rises when a stock you own rises. So you have to be holding on to a stock if you’re going to take advantage of its appreciation.
- Invest in companies that are currently paying dividends. Investing in undervalued companies requires waiting for other investors to discover the bargains you have already found. Sometimes your wait period will be long and tedious, but if the company pays a decent dividend, you can sit back and collect dividends while you wait patiently for your stock to go from undervalued to overvalued.
- Be patient. Wait for the right time to buy. Patient investors are the best prepared when opportunities emerge. For growth investors, for example, patiently awaiting the end of the bear market has led to new opportunities in the bull market.
- Recognize that perfection in investing is impossible. Not all your investments will be winners. Losses are a normal part of the business. Your goal is to ensure that your profits outweigh your losses, and the best way to do that is to have an investing discipline.
There is never a guarantee in the stock market, but there are ways to limit your risk while setting yourself up for huge rewards. Hopefully, keeping the 10 basic rules of investing in mind will help you make smart choices, weather storms when they arise, and maybe even turn you into the next famous investor.
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*This post is periodically updated to reflect market conditions.