Ground Rules for Successful Investing

Ground Rules for Successful Investing

19 Dec 2018

Warren Buffett built his wealth in the long-term making him one of the richest men in the world. He insists that "Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years." And he further says that "Our favorite holding period is forever."

Investors should take into consideration macro-economic indicators like interest rates, commodity prices, inflation and economic growth projections to maximize gains. To become a successful investor like Mr. Warren Buffett, you need to follow some of his most basic advice:-

Allocation of AssetsAllocation of assets depends on an individual's age. When you are relatively younger, you are in a better position to take higher risks, but as you grow older, you definitely need more protection. To get great returns at the age of 20, you should ideally invest 80% into Equity, Zero % in Real estate, 5% into Cash and 15% into debt. But as you grow older, your investment style should keep on changing accordingly. At the age of 40, you should invest 60% into Equity, 10% into Real estate, keep 5% as cash and 25% into debt. Towards the age of 60, your riskier assets allocation will start coming down, and you should remain invested 40% into Equity, 18% into Real estate, 2% into cash and 40% into debt. So, here we can use the rule of thumb as follows: - 100 - Your Age = Your equity exposure or allocation to equity.

Growth Trap Avoidance -In an environment where investment returns are becoming increasingly strained, many investors could be tempted to chase growth potential stocks. This, however, could turn out to be a potentially dangerous investment strategy as it often fails to take into account the associated risks. When you invest in equities, experts classify stocks with high valuations as growth stocks when the markets are on an upward trajectory. Analyze if the company can match its earnings with its valuations and always keep an eye on the stock price. It is crucial for investors to observe the capital structure of the companies.

No Impulsive Buying -Impulsive buying is the tendency of a customer to buy goods and services without planning in advance or doing sufficient research. When a customer takes such buying decisions at the spur of the moment, it is usually triggered by emotions and feelings or based on hearsay. When you invest into equities, you should not invest or commit extra resources just because everybody else is doing so – avoid the "herd mentality" at all costs. Make sure you would not need equities in the short term if you put money in it. In the short term, markets can move in any direction and can behave in an irrational manner. Also never ever borrow to trade in stocks.

Know the Right Basics -It is essential for investors to know the business of a company, its dividends, cash flows, recent performance, capital structure and the price at which the stock is available. It will be difficult for you to take a call if you do not understand the business. Price is another important factor that should be considered by investors. Stocks bought at higher prices can affect returns in the long run.

Emotions Handling -Human emotions are one of the biggest hurdles in an investor’s successful wealth creation journey. There is no harm in accepting mistakes if you end up making wrong calls and you should not be shy of booking losses either. Investors can correct past mistakes and take control and adequately protect their equity portfolio in a volatile financial environment. Let us discuss 3 common emotions in investing which we need to take care of and avoid while investing for a brighter future:-

  • Fear: Fear is one of the two most frequently talked about emotions in investing (greed, which comes next, is the other one). Fear manifests itself in a number of ways in investing and it can be the cause of many investing mistakes. The fear of losing lets investors delay the realization of a loss, which then turn into much greater losses, and the fear of giving back profits which make investors close winning trades too early. There are many facets of fear in investing as we will see later on.
  • Greed: Greed is supposed to be good, but when we look at the hard facts, greed often causes a number of impulsive investing decisions that should be actually avoided. Investors who are influenced by greed often don’t adhere to sound risk management and money management principles. Greed also reinforces the gambling mindset which describes investing without set rules and based on impulsive decisions.
  • Hope: Hope, fear and greed often come hand in hand. Investors who are in a losing position often show signs of hope when they delay the realization of a loss and give a trade more room to breathe. Another example of hope is when investors try to make up for past losses and then enter a trade with a position that is too big and not according to their rules.

To conclude, there are certain basic principles and rules that will make you a successful investor regardless of where you invest. To become a successful investor, one needs to understand the importance of discipline and planning in investments and adhere to a set of fundamental rules that have guided all types of investors with a variety of investment sizes. Each rule alone is important, but when they work together, the effects are very strong and beneficial to the investors. Investing with these rules can greatly increase the odds of succeeding in the markets.

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