There are countless books out there dishing up tips on how to become a successful investor. And the basic message of all these books is “buy low, sell high” – the buzzword of investing. But do you actually understand what it means?
No worries if you don’t because in Outsmarting the Crowd: A Value Investor’s Guide to Starting, Building, and Keeping a Family Fortune by Bogumil K. Baranowski, the book outlines the way to a successful start in investing, explaining what company stocks are and what you need to invest in them.
If you’ve ever read the financial news, you’ve probably been bombarded with information, both enthusiastic and catastrophic. You see headlines like “Google shares hit record high” or “Oil prices collapse.” Some investors become quickly distressed trying to keep up with the media craze.
But sound investing is about rationality, not emotions. Say you own stock in Starbucks and read in the paper that the company’s valuation fell by 10 percent in just one day. Your emotions may urge you to sell your shares to avoid getting caught on a sinking ship, but don’t listen to them.
If you approach the situation rationally instead, you’ll see that a 10 percent loss is an opportunity to buy more shares at a lower price. After all, you know the company has serious potential.
But rationality isn’t all you need. Investing also requires great timing. It’s essential to know when to disagree with the masses and buy when everyone is selling or sell when everyone is buying.
Good timing usually presents itself when extreme emotions are driving financial markets. For instance, during the 2000 dot-com bubble, investors were slobbering over internet companies like Pets.com and WebVan. However, it was quickly revealed that these companies had no business models, produced zero revenue and were bound for bankruptcy.
Or take the 2008 global financial crisis when financial markets fell apart due to mass panic. During this time, even sound and profitable companies saw their shares devalued. In both this event and the dot-com bubble, there were lucrative opportunities by thinking differently from the crowd: namely, by selling in 2000 when enthusiasm was at its highest or buying in 2008 when panic struck.
You might have dreams of getting rich overnight, but even the most successful investors like Warren Buffett didn’t make their fortunes so quickly.
In fact, being a good investor is all about cultivating patience and discipline, so take it slow. Rushing investment decisions is a sure way to fail. The truth is, it often takes months, even years, for an investment to turn a profit.
For instance, in recent market history, Facebook ran into difficulties soon after going public, and the stock dropped substantially only to quadruple a few years later.
But discipline can be tricky. Part of it is about letting go of the fear that you’re missing out on an investment opportunity. For example, if markets rose by 20 percent this year and you failed to invest, you might feel like you missed out.
Such feelings are natural. But in reality, there are so many publicly traded stocks that financial markets are virtually infinite spheres of opportunities. In fact, financial experts often compare missing an opportunity on the stock market to missing a train: another one is sure to come!
Finally, discipline also means not gambling with money you might need. Fear, which can drive people to make irrational choices, is the investor’s worst enemy. But it can be difficult to keep your fear from getting the best of you if you invest money you need to pay your mortgage.
So avoid making bad choices based on irrational fears and only invest money you know you won’t need for the next three to five years. Keep the rest safely planted in your savings account.
Knowing when to break from the crowd is essential to good investing, and the most effective way to outsmart other investors is to build up your knowledge every day. But before you do that, you’ll need to know where your investing competencies lie.
Warren Buffett, one of the most successful investors on Wall Street, often cites the concept of a circle of competence. The idea is that it pays to know what you’re good at and to stick to it.
Let’s say you know a lot about pharmaceutical companies. Your knowledge gives you an investment advantage in this field. But you might also be drawn to stocks in industries you barely know anything about. It’s important to avoid these and invest only in what you know. Remember, over time your circle of competence can grow if you keep learning about new investment opportunities and other industries.
In fact, continued learning will give you a profound advantage in investing. It’s pretty simple really: knowledge gives you an edge because most people these days don’t have it. The Pew Research Center’s report on reading shed light on this phenomenon: it found that 23 percent of Americans didn’t read a single book in all of 2014. Compare this number to just 8 percent in 1978.
Knowing a bit about accounting may help you read a company’s financial report, but you need to be knowledgeable about the world around you to know what those numbers mean in the current economic and political landscape. So reading regularly is imperative to succeeding as an investor.
You also need to remember that part of the investing process is learning from your mistakes. So if you sell a stock too late and lose money the best thing you can do is analyze the situation! By doing so, you can determine exactly where you went wrong and be less likely to do it again.
It might seem ingenious to come up with a complex investment strategy, but the truth is, real wisdom is about keeping things as simple as possible. So just focus on what really matters.
After all, there’s a nearly infinite number of criteria to consider when assessing a company: brand image, financial performance, the management team’s charisma – and the list goes on.
To stay focused, stick to the Pareto Principle, also known as the 80/20 rule. And the same logic can be applied to investing: stick with the indicators that matter most to you and forget about the rest of them. After all, only a few will ultimately cause a stock to appreciate.
Selectivity is another way of being focused. So you shouldn’t buy a little bit of everything but choose stocks that fit your profile.
In short, you need to apply filters. When Warren Buffet considers an investment he uses the following four:
First, do you understand the business? You shouldn’t invest in a company selling a new technology you don’t know anything about just because it seems innovative.
Second, does the company have long-term potential? After all, some industries are fads and others, like food or health care, are more essential.
Third, do you trust the management? This one is simple because a CEO that previously bankrupted several companies is a red flag.
And, finally, is the price right? In other words, if you think the stock is overpriced, move on and look for another opportunity.
Check out my related post: Why should you invest in real estate?