Many new investors spend their time trying to find the next great interesting opportunity without first learning the basics about investing. This can be a little bit like trying to ride a motorcycle if you’ve never even learned how to ride a bicycle. Sure, you may get the hang of it after a while, more than likely you’re going to fall flat on your face at least a couple of times.
With that visual note in mind we thought we put together a blog that features some vital keys to successful investing. If you are a new investor this should be required reading and, if you fancy yourself an accomplished investor, you may want to take a few minutes and look it over as well. You never know, you might pick up something valuable. Enjoy.
One of the most important of these vital keys is that you leave a margin of safety in your investment strategy so that you protect the most important part of it; your portfolio. There are two main ways that you can do this.
- Always be conservative when you’re talking about valuation and try not to assume too much. The risk here is not that you’re going to overpay for an excellent business but rather that you will end up paying more than you should for a mediocre business. When it comes to estimating future growth rates it is best to err on the side of caution.
- When purchasing any asset only purchase one that is trading at a substantial discount. If you’ve done your homework and conservatively estimated a stock’s intrinsic value should look for an extra margin of safety as well.
Another vital key is to only purchase businesses that you fully understand. Is only when you understand the business that you can estimate their future earnings. For example, a company like Hershey’s that makes chocolate will rise and fall with the cost of sugar. If you know this, and you know what it takes to produce their main product, you’ll be in much better shape to decide if they’re a valuable addition to your portfolio or not.
The best way to measure your success with any investment is to take a look at the underlying operating performance of the business that you are purchasing. Simply put, the operating results and the share price will, over time, become inextricably linked. Although it may not start out that way, the underlying business and the price of its stock almost always go hand-in-hand.
When it comes to investments there is one rule that is unavoidable; the more you pay for any asset in relation to what it turns, the lower your return is going to be. For example, a stock that you might consider a terrible investment at $50 a share you might just consider an excellent investment at $15 a share. The fact is, if you’ve done your research, have the aforementioned margin of safety in place and the long-term economics of the business are very favorable you may just view a decline in the company’s stock not as a bad thing but as an excellent opportunity to acquire more. Frankly, if all of these things weren’t in place when you first purchased stock in there there’s a good chance you probably shouldn’t have purchased it in the first place.
One mistake that many new investors make (and some that have considerable experience as well) is to trade too frequently. What happens when you do this is that you substantially lower your long-term results. Why? Because fees, taxes, commissions and ask/bid spreads create what is known as frictional expenses, something that can eat up your returns like termites can eat up your house. Even a 2% increase over 40 years could mean a significantly lower number in your retirement account when you’re ready to start golfing full-time. Simply put, frequent activity when it comes to investing can be the enemy of excellent long-term results.
The last thing we like to talk about today is the fact that, as an investor, you need to keep your eyes open for new opportunities at all times. If you’re always scanning the Wall Street Journal or the pages of Barrons or Fortune magazine something that you can add to your portfolio. Many new investors make the mistake of investing in companies that manufacture products or services that are outside of their knowledge base. Simply put, if you don’t understand the economics of an industry you will not be able to forecast where a business will most likely be within 5 to 10 years. If you don’t you really shouldn’t be purchasing their stock. (We learned this from billionaire investor Warren Buffett.)
What we’ve covered here today is really the basics but the basics are where the best investors always get their start. The good news is that you’ve already started learning and probably know more about investing strategies than many people will have much more experience than you do. Best of luck with your investing and, when you need more advice, tips and information, please make sure to come back and see us. See you then.