Principles of investing
You don’t have to be here (the New York Stock Exchange) to be a good investor. In fact, it’s probably better to be somewhere else.
There’s two ways to learn things in life. The first is through trial and error. Each time you make a mistake ideally you learn something and then you can improve the next time. Second, and the way to save yourself a lot of time, is to learn from others. Since I started to focus on investing I’ve done a lot of both. What follows are some of the principles I’ve learnt. As they say rules are made to be broken, and therefore all are to some degree flexible. Together they are part of my framework for investing, one that is evolving as I’m still only 3 years in. Sure I dabbled for many years before that time, but you only really start learning when you have a significant amount of your own capital on the line. I think it’s like that with other things in life too. There’s only so much you can learn about boxing without stepping in the ring and exposing yourself to the risk of being knocked out. Before then it’s all academic.
Invest in what you know
Truth is you don’t have to be an accounting wizard that can understand every footnote in an annual report to invest well. If you stick to industries that you know, you can do exceptionally well. Let’s say for example that you work in the pharmaceutical industry as a clinical trial manager, in that case you have a front row seat into upcoming medicines and the impact they are likely to have. You will have access to information well before the market does, so in a way you can peer into the future and see what is coming. This is a huge advantage. A lot of investing success comes from knowing just a little bit more than the next person.
In addition you will know if the company that you work for is well run. Are there good management systems in place? Do people treat each other with respect in the workplace? Do things run smoothly and efficiently? Do employees have high rates of satisfaction and stay in the company for many years? If you are answering yes, yes and yes then your company may be a great place to invest.
Beyond your own company, you also have valueable access to the grapevine of information about other companies in the industry and even suppliers and customers. This is a whole network of information that you have privlagded access to. An analyst sitting in an office in Wall St or somewhere in Singapore, no matter how clever they might be, won’t have the same level of insight as you. So use it!
2. Leave your bias and ideology at the door
I got into the condo tuk-tuk the other day to be dropped off at Starbucks. Another resident who often catches the tuk-tuk at the same time was surprised when I told him I was going to Starbucks, “ah not Starbucks! I haven’t been there for years”.
“Why is that?” I asked him.
“I don’t like it. It’s just a typical expression of American capitalism”, he said while clutching his iPhone.
He was captured by this idea that American capitalism was the root of all evil in the world, to the point where he couldn’t even recognise the benefits it has delivered. An example of which was under his nose at the time, literally.
If you’re captive to ideology, you’ll never get far as an investor. Matter of fact, much of your decision making will be compromised. The difference is in other areas of life, that faulty decision making doesn’t show up until later on, or you may actually never realise it. With investing you’ll know it for sure, because your stocks won’t perform.
Another example might be that you really support green energy, so you invest in a bunch of solar and wind energy companies. Only one problem, they are not very profitable. Sure you can have a moral compass when investing. Tobacco and gambling companies are very profitable, doesn’t mean you have to invest in them, I don’t. But you have to learn to identify your own biases and how they might be affecting your decision making. One good exercise is to catch yourself using emotive language. If you find yourself getting particularly worked up about an issue in society or in the news, and using highly emotive language to describe it, there’s a good chance you are captive to your bias.
3. Buy and hold
I had a painful experience recently. I sold off two of my biggest positions, only to watch them go up by 15-20% over the next couple of months. And this led me to set a new rule for myself, after buying a stock, hold it for a minimum of 36 months. The main reason for this is it takes about that long to see if your investment thesis is playing out or not. In the short term the market is volatile. Earnings and performance can also be volatile from quarter to quarter, it really takes a period of years to truly see how a stock is performing.
After 36 months, you will have a pretty clear indication. The stocks that haven’t performed will be at a similar price to where you bought them or perhaps lower. While the stocks that have performed will likely have diverged significantly, doubling or perhaps even more. At that point you can prune away the stocks that haven’t performed, unless you are still convinced that an improvement is on the way.
As for those that have done well, avoid the temptation to cash in your profits. Firstly you will have to pay tax on the capital gains, but more importantly you will be interrupting the compounding process. If you are on to winner, just hold on.
The other benefit of this extended time-frame is that if you’re not comfortable holding a stock for that long, it’s a good indicator that you shouldn’t buy it in the first place.
4. Limit how often you check stock prices
A trap I fell into recently is checking stock prices too often. Firstly the day to day price of stock really don’t matter if you’re a long term investor, unless you are adding to a position. The important thing is how well the underlying business is going. It’s far better to spend time understanding the fundamentals of the business than checking stock prices.
Like other distractions, such as message alerts or social media, checking stock prices interrupts the flow of whatever you are doing at the time. It can seriously dent your productivity. If I’m doing something that requires concentration, such as writing this or reading a book, I don’t even have my phone anywhere near me. I leave it in my bag, or another room.
Finally checking stocks too often gives you a false impression of how the business is performing. When you look at a the price of a stock, all you are seeing is the market sentiment at that time, which may be quite different from real business performance. If you follow stock prices too much you might be tempted to do something silly, like sell a good business just because market sentiment is bad.
I now limit myself to checking my portfolio once a week.
5. Avoid selling short, options and leverage
There’s really only 3 ways to blow up (lose everything) in investing, selling short, options and leverage. Sure on occasion you can use a bit of each, I have. But I think it should be in special cases, as opposed to your standard way of operating.
Selling short means that you’re doing the opposite of buying shares, you are actually borrowing shares to sell them. Non-professional investors can’t really access this anyway, but it highlights an interesting point. Over the long term the stock market tends to go up, so by making a bet that the price of any given share will go down, you are betting against a longer term trend. It’s a bit like waiting to climb Everest in your retirement, the odds aren’t in your favour. Investing is a game of odds, and as much as possible you want to stack them in your favour.
Options can be useful if you have a particularly strong thesis and want to maximise your returns. In particular buying calls or puts, since your potential loss is limited to your initial cash outlay. But the problem with options is that they expire, and as they get closer to expiry their value decreases. And timing the market is next to impossible. Knowing what will happen isn’t that difficult, but knowing WHEN it will happen is mostly guess-work. Therefore it’s very hard to be sure the odds are in your favour when buying or selling options.
For example we could look at the current market cap of Nvidia, around 1.78 trillion dollars! That’s more than the entire Chinese stock market is selling for. In this case it’s not hard to see that Nvidia has become a bubble and is massively overvalued. But when will it pop? We just don’t know. The thing about bubbles is they can go on much longer than we imagine. Therefore it’s better to allocate your capital where you have a higher probability of a positive return.
Finally leverage. Again in moderation leverage can be useful, but it’s a slippery slope. And it also leaves you exposed to a big shock. Take 2020 for example when the pandemic hit and stocks went down by something like 50%. If you had significant amounts of leverage in that situation you could have faced margin calls which forced you to sell, at a time when you would ideally have been buying. Leverage also makes you more twitchy and nervous about market movements. Peace of mind equals money with investing. The more you are able to stay cool, the better the decisions you can make. Leverage can work, but it is best left for the most emotionally detached and rational of investors.
6. Buy cheap
Apple may be one of the best companies in the world. Almost everyone in the developed world uses their expensive products, on which they make huge profits. They have an ecosystem that makes it hard to switch to other products. And any competitors face a monumental task trying to even come close to producing the quality of the products they offer. So should you invest? Well yes, if the price is right.
With companies as well known as Apple, you really have to wait until they go on ‘sale’ before buying the stock, otherwise you may do OK out of the investment, but not anywhere near as good as if you had waited for the right time. The right time is usually when other investors are scared. When the pandemic hit is a good example, or during the GFC in 2008. Other company specific opportunities come up too, perhaps Apply launched an unusually bad product, or the production of their iphones gets disruppted. In these situations the stock price is likely to drop, if you determine that the setback is temporary, it’s the perfect time to swoop in and pick up some stock that others are giving away cheap.
7. Pay attention to trends
We all have access to our own little investment research labs, yourself, your friends and family. One of the best ways to pick up on new trends is to see what products and services you yourself are using, then note how much you enjoy them. You can also do the same with friends and family by observing what they are consuming and talking about.
I was at a Christmas BBQ recently and the topic of video games came up. That piqued my attention as I had just invested in a gaming company. I was very happy to find out that both teenagers AND their parents were playing that companies games. That added to my confidence in the investment.
It’s very easy to get caught up in the news and how Tesla or AI is changing the world. Perhaps they are, but a better indicator of a good investment is what you yourself are using at this very moment. Then it’s not a flimsy prediction anymore, but something that is happening right now. Keeping up on the news is also important, you just need to have a good filter so that you don’t get caught up in negativity and controversy.
Avoid getting news from YouTube videos or social media, it is generally low quality information. It hasn’t been through any editorial process, it is often just someone alone in their basement saying whatever they want. Stick to a good quality newspaper like the Financial Times. If you think that all traditional media is out to get you, again you have become captive of a particular BS narrative, just one that is on the other side of politics to what I mentioned earlier. Traps exist on the right and the left. Avoid both and you can get a good idea of the way things are trending.