- Investment Rule #1: Buy low, sell high.
- Investment Rule #2: Be prepared for the prospect of losing your entire investment
- Investment Rule #3: Have an exit strategy
- Investment Rule #4: Do your homework, and do it often
- Investment Rule #5: Lighten up as it goes higher
- Investment Rule #6: Keep some cash on the side
- Investment Rule #7: Diversify your investments, but don’t “diworsify”
Here are our seven golden rules for successful investing. Using these seven golden rules with your common sense and discretion will empower you with a more disciplined approach (less subject to the whims of emotional chaos) and make you a more informed investor.
Yes, it’s that simple. The difference is your gain. Isn’t this the reason why you invest?
And it does not necessarily have to happen in that order. You could sell high, and then buy low. “What?” You ask. Yes, that is the idea behind short selling a stock. More on that later. Not that we recommend it.
Corollary 1A. Make a Grand Entry: Buy on the Dip
Who does not like a bargain? If the company fundamentals remain the same, wouldn’t you rather buy the stock at a discount? For the same dollar-value investment, you get more shares. Whenever you buy at a lower price, you less likely to get shaken out during a pull-back, and when you finally sell, you’ll get a better return. Don’t chase the stock as it goes up. Resist the fear of “missing out” of the rally. Be patient. Be very patient. It will come down to favorable levels. And when the price does dip, be nimble and quick because the discount will not last long if it’s a desirable stock.
Corollary 1A. Make an Even Grander Exit: Sell Even Higher
When it comes to selling a stock, there’s a good feeling of closure. Hopefully, you’re able to sell it for a net gain. But wouldn’t it be even better if you could have sold it even higher than you did? If you’re nimble and on top of your investment homework, you can take advantage of momentary rallies as a result of good news, whether it’s specifically about your stock, the sector that it’s in, or the market in general. If you have the luxury, wait for these opportunities where the stock gets bid up, even reaching over bought conditions.
Investment Rule #2: Be Prepared for the Prospect of Losing Your Entire Investment
Make no mistake: stocks are risky investments. When they say, “No pain, no gain.” What they also mean as a corollary is, “All pain, All loss.” Are you prepared in the event that your investment goes to $0? Not to be so negative, but because it can. It has happened to me a few times too many. If you cannot stomach a complete loss of principal, you should not be investing in individual shares of stock. Mutual funds or ETFs might be better for you.
Investment Rule #3: Have an Exit Strategy
Just like super spy James Bond would look for exits in case of threats when he goes into a building or a room. You need to formulate an exit strategy before you buy a stock. As the stock goes up, you need to have a concept of how high you would let it go. But more importantly, if it goes down, at what price would you head for the exits and take a loss? Some schools of thought say you should consider selling out if it drops 10% below your purchase price. The concept is that a 10% loss is better than a 25% loss, 50% loss, 75% loss, or 100% loss. And those heavier losses all begin with a 10% loss. Whatever your threshold before admitting that you’re wrong, that you’ve bought in too high, figure it out and write it down before you enter a position in the stock. Leave your arrogance and ego at the door. There is no room for either in successful stock investing. Are you willing to cut your losses early and exit your position? Have a plan ahead of time, so you don’t get caught by surprise by the market downturn and having to make a decision when your emotions are high.
Investment Rule #4: Do Your Homework, and Do It Often
Do your homework thoroughly before investing in any new stock, mutual fund, and ETF. Don’t rush into it. Impulse buying before finishing your due diligence is asking for trouble. And once you buy into the position, continue to do your homework every week. If your investment is very volatile, be prepared to do your homework almost every day. If you don’t keep an eye on your investments, a part of it might just disappear. Mind your Ps and Qs or someone else will eat your lunch.
Investment Rule #5: Lighten Up as It Goes Higher
When your investment goes up in price, consider taking some profits. Just as a multi-stage rocket jettisons its lower stages, lock in some of the profit and invest elsewhere. For example, sell 25%-50% of your holdings when it goes up 100%. If you sell 25% after it doubles, then you’ve removed half of your initial investment. If you sell 50%, then you’ve taken all of your initial investment off the table, leaving only your gains to run the course of the full potential of the stock. Then as it doubles again, sell another 25%. With this technique, you are ratcheting up your gains, taking a portion and eventually all of your initial capital off the table. Taking if off the table means it is safe from any stock down turn. It’s a capital preservation strategy. By selling and investing elsewhere, you are also practicing some diversification (which we discuss in Rule #7).
Investment Rule #6: Keep Some Cash on the Side
Don’t invest every single dollar that you have allocated for investing. Leave some cash on side. Ready to pounce by buying more shares on the market dips. While this is a portfolio allocation strategy, it is also a psychological hedge. Having some cash means having the ability of buying more shares of stock on corrections and major pullback empowers your inner bargain hunter. Keeping your mind off of panic and selling potentially at a loss into the correction/pullback. Instead, your focus will be on possibility of buying more shares at bargain baseline prices. This rule serves as your psychological safety net. Investing is very much a mental game, and you need all the reassurance you can get.
Investment Rule #7 : Diversify Your Investments, But Don’t “Diworsify”
Diversification is about “not putting all your eggs in one basket”. That is, don’t invest too much money in a single stock, or in a single sector (technology, biotechnology, consumer discretionary, industrials). It’s good portfolio allocation practice. By spreading your investments around, you mitigate a catastrophic event that damages the one basket.
But don’t over do it. If you spread your money over too many investments (be it stocks, be it mutual funds, or be it ETFs), you would be dividing your attention over too many investments. Remember Rule #4 about doing your homework? If you have too many stocks to watch, you wouldn’t have enough time to do homework for them all and would lose focus. You would eventually become less informed about your investments and put them at risk. Even when it comes to diversifying your investments, moderation is key.
Keep these seven golden rules of investments close. Keep a level head. And good luck!