Stock investing is incredibly challenging. That’s one of the main lessons I’ve learnt over the past ten years of writing about investing.
I’ve spent the past ten years studying and learning from some of the world’s best investors.
I’ve also had the opportunity to interview highly successful investors, authors and academics from the world of finance.
See also: 10 Traits Of Successful Investors
This experience has helped me compile a mental framework for successful stock investing. There’s no single trick or formula to follow to be a prosperous investor.
However, by following a simple set of rules, I believe it is possible to skew the odds in one’s favour and improve one’s chances of a profitable investment career.
So without further ado, here are my five rules for investing success as based on over ten years of financial journalism.
Stock investing rules for success: Minimise losses
The first and probably most important rule is to minimise losses. Every investor will make mistakes, and every investor will lose money at some point.
If someone says they have never lost money or have never made a mistake, they are either lying or have not been in the game long enough.
Investors can only do everything possible to avoid mistakes, but they will still happen. The critical difference between good and bad investors is good investors know when to cut their losses and move on.
Selling an investment with a loss can be painful, but one has to consider the opportunity cost of not doing so and weigh that against the potential loss on the sale.
The worst thing any investor can do is double down on a losing investment. This can compound losses and turn a bad decision into an even worse one.
Let the winners run
As well as cutting losing positions, letting winners run is an essential trick for stock investing success.
Several years ago, some research carried out by Wall Street analysts showed that over the past 100 years, just 4% of all US stocks generated the vast majority of the market’s returns. These were undoubtedly the best investments to hold during the period under consideration.
Around the world, there are more than 30,000 publicly traded stocks. These figures imply just 1,200 will be great investments. Finding these businesses is incredibly difficult. The odds are stacked against investors. There’s a 96% chance of missing.
Still, an investor only ever needs to find one. Finding a good business and sitting on it is one of the most straightforward and efficient ways of building wealth.
That’s another reason why it can be sensible to cut losing positions out of the portfolio and focus on the winners.
If something is too good to be true, it probably is
This is relatively self-explanatory. If something looks too good to be true, it probably is. If it were truly as good as it claimed to be, other investors would have already flooded into the opportunity. The financial markets in developed economies are incredibly efficient.
In general, asset prices reflect all available information. Funds managed by some of the world’s smartest people, managing trillions of dollars are always looking for new opportunities. When they rise, these investors quickly buy and remove the possibility of excess profit.
Occasionally, there may be something that runs contrary to this rule. However, these investments are in the minority, and there’s usually no way of telling before it’s too late. The simple rule is to stay anyway from anything that looks too good to be true.
Avoid mining and biotech small caps
Early-stage mining and biotechnology companies are some of the riskiest investments around.
They’re not risky because they have limited access to capital or are run by bad managers, but because there’s so much that can go wrong.
The percentage of mining projects that make it from the early stage of discovery to full production is less than 5%. It’s a similar number for new drugs and other treatments.
To put it another way, these companies have a 95% chance of failure. That risk generally isn’t worth taking.
Debt is a killer
The single biggest reason why businesses fail is debt. The problem with debt is the fact that it removes flexibility. Whenever a company borrows money, it must agree on certain restrictions with its creditors. If these restrictions are breached, even if the firm is the best business in the world, it will lose control.
The business world is uncertain, unpredictable and brutal. Companies face new challenges every day. Adding debt into the mix only complicates things.
Shunning businesses with high debt levels can be a simple way to avoid excess borrowing complications.