10 Golden Rules of Investing

Investing does not have to be complicated and it should not be exciting either. Putting your hard-earned money to work in the financial markets is all about helping you get what you want from life while making sure you can sleep easily at night. It is not about riding roller-coasters.

To invest, you need to draw up a clear plan, do your own research, build in a margin of safety by always thinking about the valuation and, ultimately, be patient. By all means include some speculative picks if you wish, but ensure they are only a small part of your portfolio. Looking for an oil explorer whose shares double, treble and double again is exciting but such firms are very rare. There are a lot more which have a consistent record of paying out the dividends which really make the markets work for you, once they are reinvested.

The trick is how to select the picks which best suit your investment goal, target returns, appetite for risk and time horizon. These 10 golden rules summarise entire guide and they should help everyone spot profitable portfolio picks and also escape likely failures.

1. Have a plan

The financial plan of every investment is the tool that maximizes your potential profit and minimizes risk. Depending on how fast you need make a decision and how complex your investment is, you can elaborate a detailed and accurate plan or simple plan. Before you put any cash to work, you must know what you are investing for. This will condition your target return, time horizon and appetite for risk and therefore the asset classes best suited for your aims.

2. Never invest in something you do not understand

Peter Lynch of Fidelity was one of the most successful fund managers ever, and he said he never touched anything he could not describe on one sheet of paper with a crayon. You will be angry with yourself if you lose money on something and cannot explain why. Stick to what you know and always do your own research. You can’t manage or improve something that you don’t fully understand. So before you start, gain knowledge about the subject of your investment.

3. Diversify your portfolio

“Never put all your eggs in one basket”, if the basket falls, you have no eggs left for breakfast. Same applies to investments. Diversify between debt and equity and even further within those. Invest in Mutual Funds and some direct equity if you are inclined towards equity. For debt too, choose bank FDs, Debt Mutual Funds, balanced funds, FMPs etc. Diversify. Also you can look at Gold, Silver, Real Estate, if you have the funds. If one investment class doesn’t work, the other will support it.

4. Respect the market

Stunning rises and huge crashes show that markets are not efficient, but you must respect their views. When you buy or sell something you are saying the market is wrong, so you need to have a good reason why.

5. Start with something small

There is one great strategy to start with. Start with a simple investment. Treat it as a testing ground. See how your rules work. Draw conclusions. Make adjustments. Improve. And then prepare for bigger profits. The earlier you start, the faster you will be reaping the benefits.

6. Go against the herd

Punters go skint backing favourites on the horses, and although it may work in the short-term, purely following hyped, momentum names can be dangerous. To get the best long-term returns you will eventually need to sell what everyone is talking about and buy what is being ignored – providing the valuation is right and growth, risk and quality checks are met.

7. Cash is king

Profit is a matter of opinion; cash flow is a matter of fact. Some unscrupulous managers will try and dress up their profits but they cannot fiddle cash. Accidents happen when companies look profitable but generate little cash so focus your research here when looking at individual stocks.

8. Dividend reinvestment is vital

Patient portfolio builders should focus on firms with a strong competitive advantage and a good reason why clients want to pay for their goods or services. This confers the pricing power that enables companies to generate cash and pay the dividends that really get your savings to tot up over time. There are many funds dedicated to such firms, too.

9. Never invest money that you can’t afford to lose

This parameter of your investment protects your business against losses too big to handle. Your business should run smoothly and be managed evenly and rationally. Investment business is certainly not about gambling. It is about gradually multiplying your assets.

10. Focus on value, not price

Prices are temporary, but values are eternal. Prices usually depend on values. If you are able to recognize the real value of your investment, then you will never pay too much or too less. Prices are often a matter of speculation, while values are built on passion and dreams to make a difference. Most of the time it’s good to ignore facades, diligently prepared by PR agencies and know what goes on backstage. e.g. you would not enter a restaurant and buy a pizza regardless of whether it cost Rs. 50, Rs. 100, Rs. 200 or more. You would use your judgement to decide what is good value, and the same discipline must apply to financial investments. Several simple metrics, in the context of growth, risk and quality, will help you decide whether a valuation is cheap, expensive or about right.

Do you have any specific principle of investment that your follow? It will be interesting to share your views, leave your thoughts in the comments below.