Investing can be a complicated process, even for experienced investors. For beginners, it can be an overwhelming experience that is attractive yet scary. Since some of the most rewarding investments carry a high risk, it is a good idea to consider a prudent approach when making your first few investments. Using these five rules, it is possible for you to make an informed decision and minimize mistakes. Consider each law carefully and see how it applies to your current needs.
5 Rules to Keep in Mind When Investing
Rule No. 1: Investigate Before You Invest
Never put your money into something you do not understand. Although it could be rewarding, such as if you invest in something that has an incredible growth potential and sustainability (Google and Microsoft in the early days come to mind), but many types of investments also carry a large amount of risk. Furthermore, the less you know about the company, product or industry, the less likely you will understand how it works and what types of factors can affect it in a negative way. Spend time studying the type, nature and background of the specific investment you are interested in before you make your decision.
Rule No. 2: Establish Your Safety Margin
A safety margin is a measure of protection against risks that can and will affect your assets in a negative way. If you invest without setting up a margin of safety, you could end up having some seriously impaired capital. To protect yourself and your hard-earned investment, consider the difference between the price of the stock and the intrinsic value. Theoretically, when the price of the stock is lower than its intrinsic value, it has a better margin of safety and greater resiliency against future downturns and is therefore relatively safe to invest in. This is simple arithmetic but can prove useful especially for beginner investors.
Rule No. 3: Do Not Lose Money
The one sure thing about money is that you can lose it and quite easily at that. If there is one law you need to write down right now so you are reminded everyday, this is it. Marvin Davis, a self-made billionaire, adheres to this law and recommends it to other investors. For him, it is prudent to keep your money in your bank or wallet if there is any possibility that you’ll lose it. The law is simple: if you think you will lose money, then you will. Try to be on top of the game all the time and learn everything you can in order to keep and grow the money you have. Be smart about what you do. Keep in mind that the money that leaves your hand so you can invest is money you could lose that will end up in someone else’s hands.
Rule No. 4: Don’t Let the Hole Get Too Large
If you lose, then lose only a few small ones. Don’t wait out a declining investment just so you can prove your theory right. If you have a loser, cut it or it will bring you down with it. Never spend more money on something that is obviously going down the drain. If the upside is limited and the downside is unlimited, do not stick around. Let the winners ride but eliminate the losers for your own good.
Rule No. 5: Risk is Not a Number
Many first time investors (and a few experienced ones) make the mistake of ignoring this law, focusing on the aspect of risk that is represented by a numeral or percentage point. This part may be true but risk is also the loss of capital – your capital – and this loss tends to be permanent. True, risk does and can create opportunity but it can also erode your capital just as effectively. Risk is usually associated with common investing mistakes such as failure to calculate intrinsic value, purchasing a high-cost asset or exiting a position prematurely, so watch out.