I’ve had a lot of lessons over the last 14 years of investing. Some of these were learned the hard way (losing money) and some paid me. The key is to understand what you’re doing right/wrong. I find it important to have a set of rules so you don’t make stupid, irrational, emotion-driven decisions.
- Over the long run, the market beats professional fund managers (and you)
- Time in the market beats timing the market
- Add to your positions when opportunities present themselves (buy the dips)
- Stocks will be higher in 10 years than they are today
- When stocks go down, they get less risky
- Only sell a stock if it no longer fits the reason you bought it
- Stay away from IPO’s, Penny Stocks, biotech, and options (unless you know what you’re doing)
- The market is NOT efficient, and that’s okay
- Don’t forget, if you lose 50%, it takes 100% to get back to where you started.
- Invest in companies you believe in, and understand how they make money
- Bonus rule: Follow the rules and don’t get greedy
1. Over the long run, the market beats professional fund managers (and you).
This is rule #1 for a reason. You cannot expect to consistently beat professional fund managers, and they can’t even consistently beat the market. You may have good years where you kill the market (like most people in 2020), but don’t believe it’s because you’re some kind of stock-picking genius. Over a 15 year period, the S&P 500 beat 92% of actively managed funds. Especially considering that those managed funds are going to charge you 1-2% in expense ratios, where an S&P 500 Index ETF is going to charge you 0.03% (VOO). My advice is to put 90% of your portfolio in an index fund, then use the rest for stocks you love.
2. Time in the market beats timing the market.
Don’t try to time the market. You will miss out on the biggest moves because unless you’re a time traveler you have no idea what’s going to happen. Consistently buying over time beats trying to time the highs and lows. Own an index fund, and to it weekly, biweekly, or monthly with new investment $$. This is called Dollar Cost Averaging. Never sell it because you think the market is too high.
3. Add to your positions when opportunities present themselves (buy the dips)
Despite the last rule, there are times where an opportunity presents itself. A market crash or market correction usually creates a buying opportunity. It typically seems like the scariest time to buy, but volatility creates a lot of opportunities. If you have a long term lens, it will be worth buying more.
4. Stocks will be higher in 10 years than they are today
This one is probably controversial, and there are no guarantees. That being said, the market is always recycling the companies in the S&P 500, the losers fall out and new companies come in. We’ve also seen that the US government and Federal Reserve are basically willing to write a blank check for keeping the markets pointed up and to the right. Inflation alone will push stocks higher with everything else being equal. If you don’t believe me, look at a chart of the S&P 500 over the last 100 years and count the number of 10-year periods that stocks when decreased and didn’t rebound. Then count the # of times the market didn’t rebound in less than 2 years.
5. When stocks go down, they get less risky
This is typically a difficult concept for people to understand but think of a stock as the market’s perception of the value of a company. Everyone is trying to value the underlying company. At the beginning of 2020 Tesla shares skyrocketed to almost $1k per share. I thought I missed my buying opportunity [ENTER COVID] The stock crashed about 60% in March of 2020 and I scooped up shares one day off the bottom. I thought the stock was too risky at $1k, but even with a global pandemic the 10-year growth story for Tesla was one I wanted to bet on.
6. Only sell a stock if it no longer fits the reason you bought it
Ignore the noise around a stock unless it fundamentally changes your justification for buying it. I typically have a 10-year view of any stock I buy. I look at industry trends, find the companies best positioned to own that trend, and invest accordingly.
- I’ve owned Apple for years and will continue owning it because of the massive cash flow they have. I am confident it will go up because I don’t see any major threats to their ability to generate cash flow (if anything Mac and services will continue growing). I also know that they are going to continue buying back shares aggressively with their cash flow. So either: the stock goes up, or they buy back shares at a good value share price, which makes my shares more valuable. Back in September 2020, dropped about 23% because analysts were underwhelmed by the event they had for iPads, and the iPhone 12 was delayed a month. I view this as a correction because the stock had outpaced reality, and was coming back down. I actually bought more, and am happy it went down because Apple can buy back its shares more effectively when the share price is lower. A 10-year lens makes you think like an owner, not just an investor.
7. Stay Away from Shiny Objects: IPO’s, Penny Stocks, biotech, and options
This is a big one because right now there are some huge IPO’s coming out.
- IPO’s – The whole point of an IPO is for the company to raise a ton of money at one time by selling a portion of the company’s shares. The perfect IPO would end the first trading day at issue price because that means the company maximized the cash they could have received from their IPO. DASH recently had an IPO, which started out up 80% – that means they could have gotten 80% more money for the shares they sold than they did. Or they could have sold a lower % of the company shares with an issue price of 180. It’s really a huge miss if you are the company because you are selling the company for $102 when people are willing to pay $180. I’m not blaming the company, there was a lot of dumb money thrown at this IPO.
- Penny Stocks – There is a reason they are worthless. Don’t let their fluctuations tempt you. The reason why is the spreads suck, liquidity sucks, and there are a bunch of suckers also trying to make money. There could be a day they are up 100%, but nobody out there is going to buy it from you (liquidity)
- Emerging markets (electric vehicles)/Biotech/speculative(Ex: Marijuana) – Biotech can be huge but requires a lot of approvals which can go south. Emerging markets have a lot of players that can skyrocket, but every industry has consolidation. This means at some point, the electric car industry which has a ton of startups right now, will consolidate to the top 2-3 that are actually going to have sustainable businesses. The rest will go bankrupt or be purchased for intellectual property.
- Options – Options are great. They can be a great way to hedge risk. Or make a bet on volatility. There are countless strategies in derivative markets, but they also carry a lot of risks if you don’t understand them.
8. The market is NOT efficient, and that’s okay
There is a hypothesis that the market is efficient, meaning the stock prices in all available market information and values it appropriately. I disagree because it doesn’t factor in human emotion and irrational exuberance (stock bubbles). Tesla is the clearest example of this as of right now. Almost everyone believes Tesla is overvalued. It’s currently valued at over $600B, more than every other auto company combined. It is basically pricing in 5 years of perfect execution and market expansion, along with the belief that it will transcend the traditional automotive business model. I strongly believe in the company, which is why I’m not selling, but I wouldn’t add shares unless it drops 50% from the current valuation. The fact that the market isn’t efficient creates opportunities everywhere -rallies are higher than they should be, crashes are deeper than they should be. Bad news hurts stocks in the short term, but in the long term is just noise. Don’t let the noise dictate your investment strategy.
9. Don’t forget, if you lose 50%, it takes 100% to get back to where you started
Compounding growth is the goal – and with compounding consistency and time are the most important ingredients. This is a marathon, not a sprint.
10. Invest in companies you believe in, and understand how they make money
Don’t follow the trends of the hottest stocks. Buy stocks for companies you use most. If you’re putting your own money into something, you’ve determined it’s worth your money as a consumer. Why wouldn’t it be as an investor? You also need to know how they make money or will make money in the future. What is their value proposition? I personally only invest in companies I believe are #1 or #2 in their industry.
Bonus rule: Follow the rules and don’t get greedy
If you follow these rules, you won’t have the 10,000% gains in a year people talk about because they bet on a penny stock that actually worked out. Follow these rules and you will be able to provide consistent returns with moderate risk. Your balance also won’t go to zero.
Another bonus
Make sure you apply the filters below before investing. The investment must hit all 4. Today was the IPO for Airbnb. Despite rule #7, I was prepared to invest if the price was right. It wasn’t even close, to my target, so I’ll have to wait. I may never own it if I can’t justify the price. I will go into how I value the fair value in a different post.
Munger’s “Four Filters” for picking a company to invest in
- Understand the Business
- Sustainable competitive advantages
- Able and trustworthy management
- Price that affords a margin of safety (sensible purchase price)
Are there any rules I need to add to my list? Leave a comment below!