The 5 guiding principles of highly successful investors
Do you want to be a successful investor? Well, good news! You don’t need a superior intellect, be a math genius, or possess a CFA to be one. However, what you do need is a level of emotional stability and a set of key principles to guide your decisions. Like this guy said…
“If you are in the investment business and have an IQ of 150, sell 30 points to someone else. You do have to have an emotional stability and an inner peace about your decisions.” – Warren Buffett
Without a set of guiding principles, it’s easy to get lost among all the noise — you’ll get easily swayed by the opinions of others; you’ll buy on excitement and sell on fear; you’ll make bigger bets after a run of good luck, only to lose everything and start back at square one.
Remember, being a successful investor is not about making the most amount of money in the shortest possible time, but about building your wealth in a safe and sustainable manner for a lifetime. And to do so, we all need a set of guiding principles that can stand the test of (a life)time.
Therefore, here are the five key principles you must possess to become a successful investor.
1. Think like a business owner
The existence of the stock market is for companies to raise capital and to create a market for investors to buy and sell their shares. However, the liquidity provided by the stock exchange and the ease of electronic trading makes it easy for people to forget that owning shares literally represents a part-ownership stake in a real business, not digital coupons that you trade back and forth in hopes of turning a quick profit.
When you see yourself as a potential business owner when buying a stock, you will naturally evaluate a company based on its long-term economic prospects. You will then start to ask questions like:
- Does the company have a competitive advantage that will last for years?
- Are there growth drivers that allow the company to expand further?
- Is the company run by competent people I can trust?
- Is the company profitable and have a good financial track record?
- And finally, am I getting a good deal if I buy the business at this price?
Answering these questions and more will help you focus only on high-quality companies that are worth investing in for the long term.
2. Logic over emotions
While you don’t need to have genius-level IQ to be a successful investor, you still need to base your investment decisions on sound logic. How many times have you come across people who make their decisions based on their gut emotions and how they feel? They buy high-priced stocks at the peak of euphoria and panic-sell when the market crashes. I don’t know about you but buying high and selling low seems like a sure-fire way to lose money in the stock market to me.
When you are swayed by your emotions, you can’t rationalise your next course of action when something affects your business. If a company suffers a drop in profit and a fall in share price, is the setback temporary or permanent? If a company’s share price is soaring skyward, is it backed by solid fundamentals and is it an irrational market pushing the price even higher? Knowing the answers to these questions requires a good amount of research and deduction before you can make a well-informed and logical decision.
3. Stay within your circle of competence
If you cannot tell the difference between a positron-emission tomography (PET) and a computed tomography (CT) scanner, then should avoid probably investing in the medical equipment industry; it is outside of your circle of competence. But you’d be surprised at the number of people who will readily invest in oil rig machinery, cloud enterprise software, mixed-signal integrated circuits, geo-energy solutions, or chemical product lines just for a small chance of profit when they know next to nothing about those industries.
Investing is all about parking your money in an asset that will become more valuable in the future. If you don’t understand the business and the industry it operates in, you cannot accurately assess the economic factors and potential risks associated with your investment. And, in fact, you’d be at a serious disadvantage compared to the investors who do.
Turning that around, why not invest in companies/industries that you’re already familiar with and have an informational advantage in? If you’re an expert in social media and digital advertising, then Facebook and Google should be stocks for you to look at. If you work in the hospitality line, then companies like Marriot International or Booking should be your focus at the start. This way, you give yourself the best possible chances of making money from your investments.
4. Always protect your downside
You have to invest with the mentality that the stock market is going to crash tomorrow. With that mindset, you would want to invest in companies whose earnings are resilient in the face of downturns. Because recession or not, people will continue to buy Head & Shoulders shampoo and Gillette shaving blades from Procter & Gamble. (And if you’re the type that doesn’t wash or shave during a recession, then remind me to keep 10-feet radius from you when the economy tanks.)
Since you invest in companies that are within your circle of competence, you will also know the variables that could affect their business. Whether it’s an increase in interest rates or the price of raw materials, a change in consumer preferences, or a supply chain disruption, you’d be able to tell if the situation is temporary (which signals an opportunity) or if the company/industry is in permanent decline. And always make sure you invest in companies with a fortress-like balance sheet (i.e. low debt) that can weather any downturn or temporary setback.
5. Keep a long-term perspective
As long as a company is generating steady and consistent earnings and its fundamentals remain intact, you should ignore its day-to-day fluctuations and invest with a five- to 10-year horizon in mind. That way, you can let the power of compound interest multiply your money.
During the 50-year period from 1960 to 2009, the S&P 500 returned an average of 10% (capital gains plus dividends) annually. If you had simply bought the index and held on through the OPEC Oil Price Shock of 1973, the Asian Financial Crisis of 1997, the Dotcom bubble of 2000, and the Subprime Mortgage of 2008, your $10,000 investment would have ballooned to $1.17 million. Who says it doesn’t pay to sit and home and twiddle your thumbs?
Okay, let’s say you’re that unlucky Joe that happened to invest at the peak right before market crash (9 Oct 2007) and held it till today. A $10,000 investment in the S&P 500 would still have yielded a profit of $8,550 over ten years — a return of 85.5%.
S&P 500 – 9 Oct 2007 to 13 Sep 2018. Source: YCharts
Not so unlucky anymore, huh?
The key takeaway is you don’t have to be a professional to become a successful investor. One of my inspirations is Ronald Read, a janitor and gas station attendant, who managed to build an $8-million-dollar portfolio which he willed to charity when he passed away. Read amassed a fortune simply by investing in a portfolio of stocks and holding it over a long period of time. So, if someone like Ronald without a six-figure income can do it, I’m sure you can too!
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