The truth is that you cannot be a successful investor unless you follow some time-tested and trusted principles. However, following all the written and unwritten investment rules might not guarantee success for a newbie investor. In fact, there’s hardly an investing rule that doesnât have an exception or reversal. Nonetheless, there are some investment rules that cannot be flouted. This article covers 5 investment rules that you cannot afford to break â you should only break them at your risk.
1. Cash is the worst investment ever
Money is good and even though it can’t buy happiness, it can make you comfortable even in misery. Nonetheless, the first cardinal rule of investment is that cash (not money) is the worst investment ever. All your effort to cut your spending, save more money, and invest your savings meets a fundamentally psychological need to control your financial destiny.
There’s nothing wrong with money but keeping your money (wealth) as cash is never a smart investment move. To start with, cash tends to lose its value over time and there’s practically little that you and financial policymakers can do to halt the effect of inflation on your cash. Secondly, holding cash is risky because it could be lost, stolen, or damaged.
Thirdly, there’s an opportunity cost of keeping cash versus investing in another low-risk investment such as government bonds. It should be noted that central banks are starting to consider the adoption of negative interest rates and you might start paying banks to keep your money with them.
2. If you want to invest in stocks, only buy the shares of a business that you understand
When you talk about investments, one of the first things that come to the mind of the average investor is to buy stocks. The stock market is probably the most-profiled investment arena because you can buy the stocks of companies doing something that interests you irrespective of your business interest.
However, before you jump into the stock market, you need to make sure you learn how to trade because strategic stock trading is different from trading stocks in a blind gamble. If you can’t understand and explain the underlying business of a particular company, you have no business buying the stock of such a company.
One of the smartest ways to ensure that you are involved in strategic stock trading is to buy only the stocks of businesses you understand. If you want to invest in healthcare stocks, you need to be able to differentiate between pharmaceutical stocks, biotechs, and healthcare insurance stocks.
3. Understand your risk-taking threshold and act accordingly
You can’t be talking about investments unless you are comfortable with taking risks; nonetheless, there are different levels to risk. Risk is often commensurate to rewards in the investment landscape. Hence, it is important that you understand the risk to reward coefficient of any investment before you put your money down.
An “investment” that promises you zero risk will most likely yield zero returns. A low-risk investment will most likely yield low return and a high-risk investment will most likely boast high returns.
You’ll also need to understand that investors typically have different levels of appetite for risk based on a number of factors. A 27-year old single investor might find it easier to take bigger risks than a 56-year-old married investor who is saving for retirement. More so, a 27-year old unmarried investor with $1000 might not be able to take the risks that a 27-year old unmarried investor with $100,000 will take.
4. Avoid the herd mentality, only buy low and sell high on your terms
One of the commonest investment principles is the principle of “buying low” and “selling high”. However, following the principle to buy low and sell high often pushes many investors to follow the herd to make an investment decision even when it conflicts with investment philosophy. Regular investors find it easy to follow the “advice” of the self-styled gurus, experts, and pros â yet in the final analysis, it is your money and not the money of the guru that is on the line.
If you want to buy into any investment because it is cheap, you need to make sure that you are buying because you actually believe that it is cheap and not because everybody claims that it is cheap. In most cases, the pros will tell you about a dirt-cheap opportunity when in reality they are only interested in a commission.
In the same vein, you should be wary of exiting your profitable investment opportunities because everybody is selling and getting out of the market. If you have reasons to believe that a asset has room to soar, use options to lock in your positions and leave your position intact while the bullish run continues.
5. You can make and lose money in both up and down markets
The average investor tends to seek out bullish investment trends in the hopes of making money when the value of their assets appreciates. However, veteran investors know that you can profit when the market is in an upside and when the market is in a downside if you know how to make strategic investments. In fact, real estate investors know that you tend to make your profit when you buy and not when you sell.
However, when the average investor is focused on making money on the upswing, they tend to forget that you can also lose money on the upswing if you happen to be in the wrong side of the trade. The most important thing is that investors must know how to identify opportunities in both bull markets and bear markets. You ability to profit on both upswings and downswings will increase of your odds of having more profitable investments than losing investments.
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