These 16 rules will guide you to become a successful investor, achieve good investment performance and build wealth.
Once you have learned the basics of investing, you are almost ready to start investing. As the final step, you should set yourself rules to help you make the right financial decisions and build wealth using a long-term investing strategy.
In this post, you will learn 16 investment principles that will help you become a successful investor and reach your financial goals.
You should start to invest as early as possible using a long-term strategy and making regular contributions to your investments. By thoroughly analyzing your existing and potential investments, you can avoid making emotional decisions that prevent you from achieving your maximum growth potential. Your investments should be well-diversified and never exceed your risk tolerance.
The most important rule for successful investing is to start as early as possible.
There are two factors in determining your investment success:
The sooner you start investing, the more time you have to benefit from the power of compounding. Compounding results in the exponential growth of the value of your investments if you’re able to hold them for long durations.
Another benefit of starting to invest early is that young investors have it much easier to make up for mistakes made on the way. Imagine the case that you picked an investment that is decreasing rapidly in value. As a young beginner investor, you have much more time to regain your losses than someone close to retirement. As a result, you can make investments with higher risk-reward ratios while you’re young.
Most investors want to make a quick buck and expect unrealistic returns within short time frames. However, your investments will be exposed to a lot more risk when you invest with a short-term focus, as price fluctuations play a more significant role in achieving your expected return.
If you want to build wealth and become a successful investor, you must invest using a long-term investing strategy. By investing with a long-term time horizon, your focus will move from handling short-term fluctuations to nurturing the full growth potential of your investments and benefiting from the power of compounding.
You might wonder whether it makes more sense to invest a lump sum in the beginning or if you should regularly contribute to your investments. While a lump sum can give you a good headstart to reach your investment goals, you should ideally contribute more capital in regular intervals.
By investing regularly, you can benefit from the following effects:
When you start investing, you should always make sure to understand what you’re investing into. You shouldn’t invest if you feel like you don’t have all the required information on an asset, haven’t understood how the investment works or if you don’t have a good gut feeling about it.
As an investor, you have to make assumptions about the future of an asset. Your investment thesis should mainly be based on your analysis of how the asset’s value might change and what factors might influence the price for the better or worse.
If you purchase stocks, you should understand the current state of the company, the underlying business model, the expected future earnings potential, the future growth potential, and many other aspects of the company, including the number of assets and liabilities or if the company can fund its operations without making losses.
Many people make the mistake of investing based on their emotions rather than thorough analysis. For example, they might buy investments because they see prices rise and sell them in tough times when prices fall. However, this approach is a guaranteed way of losing your money as you buy high and sell low.
Instead of following your emotions, you should form an investment thesis based on available facts and predictions. As long as the investment thesis remains intact, there is no reason to sell because of short-term fluctuations. It might even hurt your long-term performance because you might miss out on great buying opportunities. Instead, only sell your investments once your investment thesis is no longer valid.
Always keep in mind that you only lose money if you sell your investments. So never panic and sell your assets prematurely!
You might be tempted to trust the advice of forecasters and experts in the media. However, while there are many trustworthy experts, you shouldn’t trust them blindly. These influences from the media can lead you to make bad decisions quickly. Instead, always double-check their assumptions and perform your research.
The media industry makes money by creating sensationalized content that grabs the attention of its audience. The more attractive the headlines are, the more money they can make. In addition, many media outlets report what already happened rather than what they expect to happen. As a result, it is often too late to jump on the bandwagon once the media reports it.
Successful investors should know how much risk they are willing to take and avoid investments that fall outside of their comfort zone. Figuring out your risk tolerance will help you select matching investments for your investing strategy.
Once you figure out your risk tolerance, you will place yourself on a scale between conservative and aggressive investing. Conservative investors will avoid risky investments and primarily opt for bonds and established stocks. On the other hand, aggressive investors are willing to take higher risks with the expectation of an overall higher reward.
Your risk tolerance will naturally drop the closer you get to reaching your investment goals. The closer you are to the finish line, the less time you have to recover from short-term market fluctuations, market corrections, or a market decline. Preserving the value of your investments becomes more critical at this stage, and you will naturally follow a more conservative and wealth-preserving approach.
You can judge each investment you make from a risk and reward standpoint. Your job as an investor is to find the assets with the lowest risk and highest reward. Therefore you should analyze each investment thoroughly and understand its risk-reward profile.
Once you understand each investment’s risk-reward profile, you can weigh them against each other and pick the most optimal one. Remember that investment risk is not only inherent to an individual investment. However, there are also systematic risks and correlation risks that you have to consider.
Following a strategy to diversify your investments can significantly increase your chance to become a successful investor. The primary goal of diversification is to manage the risk of your portfolio. A well-diversified investment portfolio will perform well in good times but only have limited losses in bad ones.
You can diversify your investment portfolio by considering the following factors:
Including different types of investments of other asset classes can help reduce the overall risk of your diversified portfolio while maintaining good performance. For example, lower-risk asset classes will help balance investments with higher risk using this approach.
However, diversifying by asset classes alone is not enough. There might still be a shared correlation risk between your investments. For example, you might have bonds and stocks in your portfolio, but both have an underlying dependency on the oil price. If the oil price falls, this would negatively impact both investments.
As we explained earlier, different asset classes vary in their liquidity. For example, some investments, like cash, are highly liquid and can be used immediately. Other investments, like real estate or private equity, are highly illiquid and take months or years to sell.
Ideally, you want to ensure that your investment portfolio consists of different asset classes with different liquidities. This will allow you to access liquid investments in case of an emergency. At the same time, you can profit from the possible returns of more illiquid but more rewarding investments.
There is a famous saying in investing that time in the market beats timing the market. Hence, successful investing is about time rather than timing.
The future is unpredictable, and nobody can consistently predict with 100% accuracy when it’s the perfect time to buy or sell their investments. Therefore, being invested for as much time as possible beats the attempt to time the market and buy at the perfect time.
You shouldn’t wait for the perfect time to invest. Instead, grab opportunities while they exist and hold them long-term. If the price falls further, you find an ideal buying opportunity. On the other hand, a rising price means that you made a good deal.
Many beginner investors make the wrong assumption that a rising price in the past guarantees positive future results. However, in reality, nobody knows how the price of an investment will change in the future. Hence investment decisions should always be based on a thorough analysis of an investment and its growth prospects.
Investors are usually forward-looking. They base their investments on future expectations, which have typically been priced into the asset’s current market price. If those expectations are not fulfilled, the price of the assets will fall in reaction. The opposite happens if expectations are exceeded.
One essential requirement to successfully benefit from the power of compounding is not to borrow any money to achieve high growth. The interest you pay on the borrowed money compounds the same way as the value of your investments.
If the interest compounds at a higher rate than your returns, your investments might even turn into a loss-making portfolio. Therefore borrowing money to invest is one of the worst financial decisions you can make. Instead of borrowing money and investing right away, you should first work on clearing any high-interest debt you might have.
Many successful investors, like Warren Buffett, Seth Klarman, Michael Burry, Howard Marks, or Tobias Carlisle proud themselves to be contrarian investors. They achieve exceptional investment performance by buying out-of-favor investments with good and overlooked growth potential.
Being a contrarian investor does not always mean doing the opposite of other investors. Instead, it means analyzing market trends and market tendencies with a critical eye and not just following the crowd blindly.
It is not necessary to monitor your investments hourly or daily when you follow a long-term investing strategy. However, you should still periodically check your assets and whether they are still on track to reach your financial goals.
Todo this, you can check your original investment thesis and check if it still applies to the current state of the investment. Maybe a milestone has been reached leading to the investment thesis being fulfilled, or the market environment has deteriorated, and there has been a setback. In those cases, it makes sense to understand if you should still hold the investment or if there are other investments with better growth potential available as a replacement.
However, the right balance is needed, and you shouldn’t check your investments too frequently as your human emotions might counteract your financial decisions. By being exposed to constant price fluctuations, you might sell assets prematurely, negatively impacting your investment performance.
Like borrowed money, taxes and fees also affect your overall investment performance as they slowly eat away the benefits of compounding. First, you have to consider brokerage fees. You usually have to pay both for buying and selling your investments. Secondly, you have to consider any taxes, like the capital gains tax or income tax, as well as your tax rate. The higher these fees and taxes are, the more significant the impact on the investment performance will be.
Learn more about fundamental investing concepts in this recommended post.