Once you know the basics of investing, it's time to start investing. These 14 rules will guide you to become a successful investor.
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. These rules should be your guiding principles to avoid losing money and reach your financial goals.
In this chapter, you will learn 14 investment principles that will help you become a successful investor and reach your financial goals.
By far 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. Therefore, the sooner you start investing, the longer the value of your investments can compound and the higher your final return will be.
In addition, as a young beginner investor, you have much more time to regain your losses than someone who is closer to retirement. As a result, you can take higher risks and grow the value of your investments faster while you’re young. In addition, the sums you will invest will also tend to be smaller. Therefore your losses will be less significant, while you will still be able to make important learnings.
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.
You must invest using a long-term investing strategy if you want to build wealth and become a successful investor. By investing with a long-term time horizon, your focus will move away from caring about short-term price fluctuations. Instead, you can benefit from the power of compounding and experience the full growth potential of your investments.
Investing might seem intimidating because it might look like you will need a lot of money upfront to make a profit. Investing in a lump sum can give you a good headstart to reaching your investment goals. But instead of investing a lump sum, you should ideally contribute more capital regularly.
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. 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.
Don't invest if you feel like you don’t have all the required information about an asset, haven’t understood how the investment works or if you don’t have a good gut feeling about it.
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 realistic expectations. As long as your 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 remember that you only lose money if you sell your negative investments and realize your loss. 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 as it is easy 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. Therefore, the more attractive the headlines are, the more money they can make. In addition, they 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. 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. Once you understand each investment’s risk-reward profile, you can weigh them against each other and pick the most optimal one.
Therefore you should analyze and understand the risk-reward profile for each investment you want to make. This does not just include unsystematic risks that are specific to the asset itself, but also systematic risks and correlation risks.
You can significantly increase your chance to become a successful investor through portfolio diversification. The primary goal of diversification is to manage and reduce the risk of your portfolio while maintaining a high return. 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:
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.
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.
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.
Some people make the mistake of borrowing money to make "guaranteed" returns from their investments or achieve faster growth. However, borrowing money to invest is one of the worst mistakes you can make when investing. You always have to pay back your debt, no matter if your plan worked out.
At the same time, the interest on the borrowed money weighs down your investment return and compounds like your return. Therefore, your investment return has to match the interest rate of your loan just to break even. If the interest compounds at a higher rate than your returns, your investments might even turn into a loss-making portfolio.
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.
You should check your original investment thesis periodically and see 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.
But, the right balance is needed as you migt be tempted to make emotional decisions if you check your portfolio too frequently. 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. Therefore, you need to take taxes and fees into account when you calculate your real return.
First, you must consider brokerage fees and commissions that you will usually have to pay for buying and selling your investments. Secondly, you have to consider any taxes, like the capital gains or income tax. 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.