Every now and then I like to bring things back a notch. A return to the fundamental principles of investing.
Most of the time we try to bring you ideas and opportunities that sit a little outside the box. They’re not typically views or ideas you get in the mainstream. But then again, the mainstream is also horrible at providing fundamental knowledge that every investor needs to know.
It might seem silly, but a lot of people don’t even know the basics of successful investing. It’s one thing to bring you wild investment ideas. But if you don’t know how to put them into action, then it’s all kind of redundant, isn’t it?
That’s why I’ve prepared these five key things I think every investor should have as the basis to their strategy. Do these and you’ll have a solid platform needed to launch from. Which will help you be ready and capable of investing in all kinds of different, wild, and wonderful opportunities.
1. Knowledge is everything
I started learning about stocks around the age of 11. It was probably a little before then. But my early memories are at that age. I knew what a dividend was before most kids were able to ride a bike.
I tell you this not with a big head, but to make a point. It’s never too early to learn about investing. And it’s never too late. Also the earlier you can help educate your kids or grandkids about it, the better off they’ll be as well.
That’s because they simply don’t learn enough about it at school.
The more knowledge you have about markets, key terms, and financial language the better. You might know what a P/E ratio is, but do you know why it’s a good metric? Do you know how to look at a cash flow and balance sheet and understand what each line means? Even more importantly, do you ever follow that deeper to the appendix to really dissect what the numbers mean?
Do you know why that’s even important?
Information and understanding what that information means is crucial to making smart decisions. It will help you buy, sell, and hold a position with greater confidence.
It can also help you avoid a position altogether. And sometimes knowing when to pass is more important than knowing when to buy or sell.
2. Have a plan
There’s an old adage, ‘fail to plan, plan to fail.’ It rings very true in the world of investing. Great investment ideas fall to the wayside if you don’t have a plan of attack. You need to set the right goals for the right time frame and the right outcomes.
A plan should be more than just ‘make money’. It should be more than a thought in your head.
This applies to investing, saving, all aspects of finance. Maybe you’re trying to save for a house deposit. Maybe you want to save to invest in stocks. Maybe you want to do both.
Or maybe you want to build a long-term trust for your kids. Maybe you want to build assets for retirement. Maybe you want to do it all.
You can and should have multiple goals and multiple strategies. Each strategy should be specific to the outcome of the goals you set. This impacts where you invest, why you invest, and how long you invest.
You should have an overarching plan for wealth creation. You should know what strategies to employ to reach your goal. You should also have a number of sub-strategies and plans to tick off along the way.
3. Understand risk/reward
The balance between risk and reward is critical.
Often in investing, the higher the risk the greater the potential reward. Risk is a premium you pay for a potential gain. If that gain is potentially huge, that means the risk is likely huge too.
Risk also means a chance to lose it all.
This ability to understand and accept risk is crucial to build wealth. It’s also influenced by your time frame. And this comes back to the idea of having the right plan and strategy.
You can also manage risk by investing the appropriate amounts. If you’re looking at a high-risk investment, then you don’t want to ‘bet the house’. With high- and ultra-high-risk investments, you really need to be prepared to have it fail.
Of course you never enter an investment to lose all your money. But with ultra-high-risk opportunities, it’s a real possibility. Investing in a crypto or microcap biotech are examples of these kinds of all-or-nothing style plays.
The sooner you realise your risk appetite, the better off you’ll be.
4. Back yourself both ways
You’ve done your research. You understand the industry. You understand your plan. You know where your risk appetite sits. You’re ready to make a move.
Here is where investors often breakdown. Fear sets in. Alternative FOMO kicks in. Right at the point of action doubt always creeps in.
‘What if I’m buying too high?’
‘What if I’m wrong about it?’
‘Maybe those other stocks everyone is talking about are better?’
Pulling the trigger and actually buying a stock is hard. That’s when you actually see your cash balance decrease and your shareholding increase.
There’s only one thing to do. Back yourself.
Have conviction in your process, your plan, yourself. Sometimes you should also listen to your gut feeling, both good and bad.
But it’s when you do get one wrong that things get hard. And you will get one wrong.
This is why you’ve got to know how accept a loss. And it’s important to know when to accept a win.
Selling out of a position is harder than buying into one. Selling out of a big gain is often harder than selling out of a big loss.
Let’s say you’re sitting on a big winner. Maybe 1,000% or more. The feeling is to let it ride; it might go to 2,000%. But here’s where your plan is important. Be smart, know when you’re on a winner, learn how to take profits and when to take profits. Know that partial profits can also be the right call.
Backing yourself out of a position is just as important as backing yourself into a position.
5. Don’t be a sheep
This lesson is hard to learn. And it relates to the point above. It’s a part of the human condition to want to be part of a group. Instinctive tribal behaviour. To share with others’ similar experiences.
But investing with the masses can lead you right into the middle of the bell curve. Or as I like to put it, right into the guts of mediocrity.
The average investor gets their information from the mainstream media and large investment research houses. They cover a narrow array of investments. They look mainly at large-cap stocks, indexes, ETFs, and the kinds of things that appeal to the mass market.
But that’s not where the real wealth, the life-changing opportunities are. If the best investment opportunities were all mainstream, then everyone would be bloody rich already.
But they’re not.
Smart money always looks for fringe ideas. Sure they can be high risk. They can also carry high potential. And that’s where your understanding of risk becomes so important.
Don’t be like ‘Steve and Sheryl’ at the BBQ. Be unique. March to the beat of your own drum. Have conviction, the right strategy, the knowledge, and understand your risk. Those are the hallmarks of a great investor.
Editor, Money Morning