The goal of this post is to serve as an introduction of investment principles to those who wish to start investing in the stock market. These concepts are timeless and by no means replace a full read on the book they were based on – The Intelligent Investor by Benjamin Graham.
If you’re not familiar with stocks yet, I encourage you to read this brief introduction before continuing with investment principles.
Investment
There’s no other way to start this post other than describing what an investment should be. According to Benjamin Graham (herein referred as Graham) you should:
- Thoroughly analyze a company, and the soundness of its underlying business, before you buy its stock
- Deliberately protect yourself against serious losses
- Aspire to “adequate”, not extraordinary, performance
A wise investor doesn’t fall for temporary gains or day trading techniques presented by other investors, but rather in long-term results. Any strategy that doesn’t include all 3 statements mentioned above, is unlikely (not impossible) to succeed in the future.
Failing to diversify your portfolio, picking the hot stock just because everyone else is, or deciding to stock-pick without any prior study, is the first step to failure.
Whenever you ignore one of these points, you’re entering the field of speculation and leaving aside the core values of investment principles.
Speculation
What are the signs that you might be speculating on an investment?
- Thinking that you’re investing when you’re actually just gambling
- Lacking the proper knowledge and skill for it (and not working to improve on that)
- Risking more money than you can afford to lose
Despite all the ‘bad’ things associated with speculation… it can also be a good catalyst.
Without some degree of speculation, untested startups with potential, might not find the capital they need for expansion.
Would You Risk All Your Money in The Casino?
You might have noticed in the amount of Gurus out there in the latest times. There’s always someone claiming to have found the secret formula and charging a price for it.
Would they really share it, if it actually worked? Doubt it.
Usually a few years or months after these announcements, the strategies don’t work anymore, why’s that?
Because they were either based on random statistics, or if everyone does the same, it ends up losing its value.
Here are some tips from Graham to avoid speculating:
- You must never delude yourself into thinking that you’re investing when you’re speculating
- Speculating becomes mortally dangerous the moment you begin to take it seriously
- You must put strict limits on the amount you are willing to wager
A good rule of thumb is to put a limit of 10% out of your portfolio to play with it.
The True Investor
Many investors are unjustifiably worried about market declines, thus turning their basic advantage into a disadvantage.
Usually in Wall Street, the views are either too optimistic or too pessimistic. Funny enough, when they’re super overvalued or at a bargain, respectively.
The intelligent investor pays attention to the current prices and only acts upon it in to the extent that is favorably enough to sell it.
The rest of the people would be better off if the stock market had no quotation at all, in order to avoid the each others mistakes of judgment and all the mental pain and anxiety.
Mr. Market
In his book, Graham wrote a parable that illustrates well what happens with the common investor.
Imagine you own $1000 of a business and Mr. Market is one of your partners. He often makes good assumptions about the price of the stock either when it’s up or down.
Sometimes Mr. Market gets too enthusiast and wants to convince you to buy a stock that is currently overvalued. He might also be too scared of a sudden price drop and tries to instill that fear in you.
Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop.
Benjamin Graham
Observe, Analyze, Act
Would you listen to an euphoric person telling you to buy or to sell your investments just because they went up or down in value?
When analyzing a drop, pay close attention in terms of percentage values rather than the absolute value. Would you care if the temperature dropped 1%? Of course not. Follow the same logic when the S&P 500 drops similar amounts.
All the news companies are interested in getting their viewers attention. One of the best way to do that is by fear.
So the next time you see some commentaries on the last bear market, picture in your head “SALES 50% OFF” rather than selling and losing money to someone else (considering you were confident and studied before choosing your stocks).
Another analogy is to consider if you’d be checking your apartments price every day if you had the chance to do so? Imagine the price dropped 20%, would it be a good time to sell your place? No!
What Are Good Investment Principles?
There’s no such things as “good” or “bad” stocks. Let’s say a bad company has its stock price too low, then it becomes a good buy if it’s underlying business is doing well! The opposite applies to a good company having its stock price too high but with a weak underlying business.
Graham also gives some tips that can he considers decisive before buying an individual stock:
- The company’s “general long-term prospects”
- The quality of its management
- Its financial strength and capital structure
- Its dividend record
- And its current dividend rate
The main thing to retain here is, don’t buy a stock just because it’s price has been going up. If you do so, then don’t expecting anything other than failure.
Unless you’re able to dedicate a full-time role to study all of these factors about a company, focusing on tracking market indexes might be a safer and also solid strategy to diversify your portfolio.
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