1) Never Eat Anything Larger Than Your Head. OK, it’s not really a rule exactly applicable to investing, but I think it’s a pretty good rule for staying healthy. The healthier you are, the longer you can enjoy the magic of compounding…
2) Know the Difference Between a “Trade” and an “Investment.” A “Trade” is a short-term “bet” (for the lack of a more elegant term) that something will happen and the result of that something will be good for the stock you bought. A reasonable trade always has a trigger event and a deadline. Buying a stock because you think it will report better-than-expected earnings is a classic example. An “Investment” is something you tend to hold for a longer time.
3) Don’t Let “Trades” Become “Investments.” So what do you do when the earnings results are disappointing, and the stock you just bought for a trade goes down? The temptation is to hold on and try to recoup your losses, but the rule #2 dictates that you sell it. You were wrong. Move on.
4) Limit Your Sources of Information. This may seem a bit counter intuitive, but I think it works. Listening to too many outside sources can often lead to confusion. This is especially true of the more popular media outlets dedicated to capital markets commentary. In my work, I follow closely two or three equity strategists, a like number of economists, one bond market “guru” and a handful of sell-side analysts. I note in passing a large number of other sources, but usually pay them no mind. Some popular sources I actually consider potentially dangerous to one’s portfolio.
5) Always Know Why You Own Something. At whatever point you are not sure why you own a stock, you should get rid of it. By the way, merely thinking a stock might go up is not really a sufficiently strong reason to hold something.
6) Never Get Involved in a Land War in Asia. Again, not exactly a key principle for investing, but it underscores that fact that much wisdom about life in general can be gleaned by simply watching “The Princess Bride…”
7) Never Buy a Stock on Another Person’s Recommendation. Actually, that’s a bit strong. The actual rule is don’t do this unless you have considered how that recommended stock fits into your way of investing or into your portfolio. Understanding the appropriateness of any investment is critical to portfolio balance and risk management. Buying a stock just because some famous person on television (or your cousin Ned) recommends it is a recipe for randomness.
8) Never Buy a Stock on “Gut” Feeling. Intuition may serve us well in many endeavors, but in the investment world, it only helps after we have done all the hard work to truly understand the asset we are considering. Seasoned Wall Street pros will often talk about the importance of gut feeling in their investment making process, but if you press them, they will admit it’s only about 5% (or less) of the total work required to find, analyze and select a successful investment.
9) It’s Better to be Disciplined Than Smart. The most successful investors I know have lots of rules that they have crafted over many years of experience. They also follow them more or less religiously. Sometimes your particular investment approach will not be rewarded by the markets. That is no reason to abandon it. Successful rules will more often lead to outperformance than trying to guess what approach will work next.
10) Sometimes the “Right” Thing do to is to do Nothing. Many people fall into the trap of feeling they must react to events affecting their stocks or portfolios. More often than not, simply taking a deep breath and re-evaluating the merits of the investment is a much smarter approach than simply selling (or even buying more). Understanding whether you are using your emotions or your cognitive abilities when approaching a key investment decision is a critical key to success.