Ten Commandments that point to a better path to wealth
Beginners, thou shalt not covet the investment clichés.
If heaven had been a stockmarket, Moses might have come down from the Mount bearing two, entirely different, stone tablets. The Ten Commandments of equity investment perhaps, a philosophy designed to sell investment products and keep the clients in them with as little hassle as possible.
They might have read something like this:
- The market always goes up.
- Buy and hold.
- Invest for the long term.
- Rely on the miracle of compounding returns.
- Invest in businesses not stocks.
- You can’t time the market.
- If you aren’t willing to own a stock for 10 years don’t think about owning it for 10 minutes.
- Our favourite holding period is forever.
- In the short term the market is a popularity contest. In the long term, it is a weighing machine.
And much like the real Ten Commandments, most beginners in the stockmarket adopt these subliminal directives without really arguing them through or asking “Do they make us money?” I’m not sure they do. These are philosophies designed by product sellers to keep us invested; philosophies that serve the financial industry’s purposes first and ours second.
So, beginners can start with a blank canvas, not with a brain befuddled with stockmarket cliches.
The stockmarket is not easy. Approach it without a business-like structure and you might as well shake a bag of money off the top of a mountain. Would you give $10,000 to a stranger to invest if they didn’t have a convincing framework that worked?
Treat it like you were running a business: have systems, records, rules, a budget, goals, risk management, attrition and constant improvement. Without method and reporting, without structure, nothing will improve. The alternative is what most new investors do, make it up as you go along.
Pride and prejudice
Making money is not about predicting the future, nor about setting stocks in stone on the back of faultless long-term analysis. And it is not about being right and having faith. It is about entering stocks with a high probability of them going up over your chosen timescale.
That’s the best you can do. It doesn’t involve predicting the future. It doesn’t require your judgement to persist beyond the moment of purchase. It involves playing the odds, and it is done on the understanding that things change.
Professional traders know this. They are not proud. They know that things will change, that they will get things wrong. The difference is they do something about errors rather than stand by some grand but flawed declaration through thick and thin.
There is no room for pride and prejudice in investment, or for liking or hating. Those emotional responses have no value in a market devoid of emotion. Understand that investing in share prices rising is not about black or white, but about probability and your game is to narrow the odds.
If you can understand that anything is possible and that no one knows the future, you are half way to being ready.
Let’s face it, if all the kings and queens, presidents, central bankers, brokers, financial advisers, accountants, doctors and taxi drivers didn’t know there was going to be a global financial crisis, how can you possibly know what’s going to happen next?
The best you can do is invest in the likely, based on your research, but be watching when it goes wrong and be decisive in doing something about it. Things change. This is not a job for someone who has “faith” in stocks or the market.
The often subconscious suggestion that you should never sell comes from years of indoctrination that the market only ever goes up, that doing anything short term is rash, and that because intelligent investors like Warren Buffett ignore the short term, others should too. But not selling is the Achilles heel of any investor.
Hopefully you will find out very quickly that selling puts you back in control, with cash and all the options in front of you. The emotion, fear, greed and sleeplessness disappears and suddenly you are waking up hoping the stock that was upsetting you goes down, having spent a month ripping your hair out because it wasn’t going up.
Holding cash is a powerful position. Do it often as a beginner because you learn more from selling. Selling invites analysis of what happened and through that experience comes improvement. Hold a stock until it goes bust and you learn nothing.
Two sidenotes: 1. The financial industry is here to get you in, not let you out. They almost never sell. The decision to sell should be yours and if you use a broker or adviser, you will have to be assertive to get it executed. 2. If anyone tells you “If you never sell you never take a loss”, they’re an idiot.
Being short term
But anyone who plays the market in the short term goes nowhere in the long term. How many people have to say this before investors learn. Does every investor have to lose money first? Experience will teach you that you will not make money if you focus on today’s stories and ideas. You will make money picking stocks you expect to go up forever, not today.
Investing is not for the impatient. If you are impatient you have unrealistic expectations. If you want to be a successful investor, lower your expectations. Investment is about consistent returns over a long period of time, not about making a killing.
What to do
Let me propose an alternative Ten Commandments for any new investor:
1. Focus on just a few stocks. You cannot transform yourself with 20-plus. If you want extraordinary returns find one to five stocks that you get to know very well.
2. Do the hard work. Spend one hour doing work on a stock and you will end up in the top 1 per cent of people who know anything about it. Do 10 hours work and you end up in the top 0.00001 per cent who know anything about it. Someone who has followed and traded the same stock for a year has an even bigger edge. Get to know a few stocks. Find some favourites.
3. Be contrarian. There is no transformation in playing with the herd. Learn to identify extremes. Armageddon is opportunity. I doubled my money in Elders one year and could have tripled it. Doing the work and spotting the turn is where the money is, in what the market doesn’t expect, not what it knows.
4. Develop a technical discipline. Technical analysis alone will not make you rich but it is a tremendous risk management system. A share price is not a line on a chart but that line represents thousands of people saying, “You’re right” or “You’re wrong”. That’s a useful piece of information. When they start saying you’re wrong, don’t be smart.
5. Network. Ten ears are better than two. Expand your group of investing friends. You only need one or two ideas a year, so what if you do waste a few hours over a bottle of wine and strike out?
6. Use everything. Use fundamental research and technical trading skills. It’s all contributory information. Too many value investors and traders are blinkered. Pride? There’s no place for that.
7. Don’t make mistakes. You cannot transform yourself with good stocks if bad stocks are constantly chopping you down. Controlling losses is easy because they are right there in front of you on your spreadsheet. Sort them out first.
8. It’s about stock prices, not businesses. It’s an arrogant investor who thinks their money is invested in a business when the herd controls the share price. Share prices are half psychology, half value, not 100 per cent of one or the other.
9. No ego. No one is that good at investing and cannot learn something new. You will change your methods many times so be flexible, respectful and open-minded.
10. Enjoy it. No one does anything well when they must.
ASX Sharemarket Game is a great way to learn about buying and selling shares, without using real money.