Here are the 7 Golden Rules of Investing that made successful investors such as Peter Lynch wealthy beyond your dreams.

Fund managers wants to keep you in the dark on these important rules on investing, so you may believe they can invest better than you.

In my other article, we shows that small investors like you have advantages over big fund managers, advantages that you have that even Warren Buffett envies.

Now we shall level the playing field, and uncover the Rules of Profitable Investing that successful investors like Peter Lynch uses.

If you want to be successful, this article shall give you an extra edge over all the other investors around you, and even many of the professional fund managers.

Warning! The following rules of investing may shock you.

These rules of investing may change your life.

Let’s Dive In!

7 Golden Rules of Profitable Investing

Every road to success have a certain rules to follow, same goes for investing. Amount dozens of rules for investing, there are a few that stand out the most and should be followed by every investors who want to profit from the stock market.

Here are the 7 Golden Rules of Investing that all successful investors follows:

  1. Don’t follow the crowd
  2. Invest don’t gamble
  3. Know the value, know the price
  4. Diversify
  5. Don’t listen to expert’s forecast
  6. Invest in what you know
  7. Beware of fear and greed

1. Don't Follow The Crowd

“Be fearful when others are greedy, be greedy when others are fearful.”

Investing Advice from Warren Buffett.

These are the words that Warren Buffett said when asked on the advice on investing. In other words, “don’t follow the crowd”.

Although this sounds easy, but it is actually easier said than done. Simply because following the crowd is basically our natural instinct.

In the wild, animals tent to stick in a herd because of safety in numbers, when the predators are here, their chances of survival will be much higher.

But in investing, sticking to the herd have the opposite effect. Instead of safety in numbers, if you follow the herd for investing, you will most likely loss your investment or at most be mediocre.

The Reason is Simple:

If you follow the average, you will be part of the average.

But in most case, because of the human nature of selling when fearful and buying when greedy, most beginner investors do worst than average.

They tend to buy when when the stock price is sky-high and sell when the stock price is very low.

If investing is to buy low sell high, following the crowd will lead you to do the opposite.

By following the crowd, these investors follow the crowd and made the wrong decision at the worst possible time.

Let’s check this short video by National Geographic on an experiment on herd mentality.

Herd Mentality

2. Invest don't Gamble

Some people says that investing is basically a form of gambling. This maybe true to a certain extend but I don’t totally agree. In a short term, you will get a 50% probability that the price going up and 50% probability that the price going down. But in a long term, the price of the stock always reflect the value of the company.

Short Term ‘Investors’

Many ‘day-traders’ who invest for the short term call themselves investors, which I don’t really agree.

Day-traders trade on the fluctuation of the market of the short term. They trade on the price of the stock that is driven by the human greed and fear. The price they trade will give them a 50% probability of stock price to go up and down.

The value of the company itself is not taken into consideration, but instead the unpredictability of human behavior is used in each trade instead.

Although, they do use technical analysis to help them in each trade, I don’t really agree that they are called investors.

Long Term investors

On the other hand, successful investors such as Warren Buffett invest for the long term. They don’t invest on the unpredictability of human behavior but on the value of the company itself.

Warren Buffett have been famously quoted ‘Our favorite holding period is forever.’

What? Forever?

Yes, that is how he made his billions. Simply because when you have found a great company, you want the company to help you grow your investment.

In a short term, the price will most often not reflect the value of the company. But over a long term, the price of the stock will reflect the intrinsic value of the company.

Investing is about buying a good value stock for a low price and sell it when the price is high.

3. Know the Value, Know The Price

We loves to do shopping and it is always exciting if we are able to get a great deal. Thus, the same concept goes for buying stocks. Whatever stock we are thinking of purchasing, we will always want to know that we are not overpaying it, but buying it when it is ‘on sale’.

Great stocks goes on sale once in a while, especially during the market crash. But how do we even know if the stock is currently on sale.

Warren Buffett explains:

“Price is what we pay, and value is what we get.”

Every company (represented by its stock) have its own intrinsic value.

(Intrinsic value is the value of the company if you are buying the whole company.)

Price is what most people ‘think’ the company cost right now which is controlled by fear and greed.

Most of the time, the price of the company and value of the company is similar, but once in every few years the value of the company and the price differs.

  • Price of the stock is more then the value of the company, it is called overvalued.
  • Price of the stock is less then the value of the company, it is called undervalued.

Stocks become overvalue and undervalue during 2 different occasions:

  1. Stocks become overvalued when the market is too optimistic, generally during a bull run.
  2. Stocks become undervalue when the market is pessimistic, generally during a bear market or market crash.  

For investors who wants to make a profit from investing, they buy the stocks when the stock is undervalued and sell it when it become too overvalued. Thus, knowing the value of the stock is just as important as knowing the price of the stock.

4. Diversify

Diversification is especially important for investors who do not have time to manage their portfolio, or those who only have a basic knowledge on investing.

This rule is important to most investors. Even though, diversification won’t get you a stellar return on your investment, but you won’t do very bad either.

Diversification is a great protection against ignorance. So, unless you are Warren Buffett, or Charlie Munger, who is amazing in finding great stocks by studying the balance sheet and income statement. The best advice is for you to diversify your portfolio.

There is an old saying of “Don’t put all your eggs in one basket”.

Holding a portfolio of just one or two stock can be pretty dangerous when things goes south. Diversification is to hold a portfolio of investment with a low correlation to each other.

Wrong Way of Diversification

Some people ‘diversify’ by buying 30 stocks from the same sector or industry which are highly related to each other. In other words, when one of the stock falls, all the other stocks will fall as well. Because all are from the same sector or industry.

Not only you have to manage 30 different stocks, which a lot of mistakes can happen, this is a wrong way of diversification.

Right Way of Diversification

The right way of diversification is to buy stocks which does not correlate to each other. And the best way of buying such stocks are by buying the respective Exchange Traded Funds (ETFs).

ETFs are a low fee basket of stocks from that sector or industry where it is professionally managed to reflect the sector’s or industry’s general performance.

An example of a diversified portfolio is as follow:

  • W% Gold ETFs
  • X% Bonds ETFs
  • Y% REITs ETFs
  • Z% Blue Chip Stocks ETFs

Gold and bonds are usually inversely correlated to stocks and REITs.

This way, your investment portfolio will generally have less fluctuation and you will have a good night sleep each night.

There is a Golden Ratio on how much % should you place your money on each investment tools.

In our future articles, we shall discuss about the All Weather Portfolio which is first introduced by hedge fund manager Ray Dalio and popularized in Tony Robbins’s book MONEY Master the Game: 7 Simple Steps to Financial Freedom.

5. Don't Listen to Expert's Forecasts

Most experts will hate me for this, but don’t listen to expert’s forecast, or at least listen with a pinch of salt.

Don’t get me wrong, I am not saying all experts are bad, they definitely know their stuff about investing, they are experts.

It is just that when the expert tells you what is hot right now and what to buy or what to sell. It is already too late in the game.

When they make a recommendations on certain stocks, the stock might already be overvalued by the time you learn of the news. Other investors might already be taking out their profit. New investors who just learn of the news may now  be buying the same stocks at all time high which is not something you should do.

On the other hand, when the experts ask you to sell a certain stock because of some ‘secret’ news source they are not telling you. The stock may already be all time low and is now a bargain. Somehow, the value investors are buying at the same price that the new investors are panic selling because some experts say you should sell.

Be extra mindful of expert’s forecast on a certain stocks and do your own research before you make the next buy or sell decision.

6. Invest What You Know

Everyone have different background and have different understanding of different industry. Stick to investing on what you understand and stay away from those which you don’t.

Warren Buffett calls it,

“Invest in your circle of competence.”

You don’t get successful in investing by knowing a bit of every industry, you profit from investing by being knowledgeable about a few selected industry which interest you.

Warren Buffett buys Coca Cola in 1988, not long after the famous Black Monday. With a low price and a great value, Warren Buffett purchased 23.35 million shares of Coke. Since 1988, Coke stocks have climbed 1,750% and make Warren a very wealthy man. With a current ownership of over 400 million shares of Coke, Warren is getting half a Billion dividend yearly.

How Warren Buffett make such fantastic investment?

Simply because he and many other successful investors, invest in their circle of competence, or in other words, invest in what they know.

You can too make such a great investment, but first you have to find the few industry which you know best.

Here are the steps on finding you own circle of competence:

  1. Draw 2 circles slightly overlapping each other and each give a title
    • My Passion
    • Where I Earn/ Spend My Money
  2. Fill each circle, if that items falls on both category write it in the portion where the circle overlaps.
  3. Now see what are the items that is found at the overlapped circle
  4. Select 3 items and research on stocks that is related on these 3 items.
  5. These stocks that are related to these 3 items will be your first cicle of completence

Getting your circle of competence is just your first step, then next step is to be very knowledgeable about it and then allow you to make the right investing decision in the future.

7. Beware Fear and Greed

Perhaps the most important rules of investing is to avoid the traps caused by your own fear and greed.

Basic human emotion is the greatest enemy of profitable investing.

You can be a short term day-trader, or a Warren Buffett style long-term investor, a discipline approach is the key to profit from investing.

All successful investors plans each investing decision, they ask a few questions before they buy, or sell a stock.

Before they Buy:

  • They ask themselves the reason why they want to buy a certain stocks and not the other:
    • Is it because that others are buying, thus they buy?
    • Is it because someone said it is good, thus they buy?
    • Is this buying decision emotional, or because it is a right decision?
  • They check if they are falling into the trap of Greed before their investing decision.

Before they Sell:

  • They ask themselves the reason why they want to sell it now and not later, or earlier:
    • Is it because that others are selling, thus they sell?
    • Is it because someone said it is right time to sell , thus they sell?
    • Is this selling decision emotional, or because it is a right decision?
  • They check if they are falling into the trap of Fear before their investing decision.

Don’t let your emotion take control of your decision. Make you investment decision based on facts and figures will allow you to be much more successful in investing.

My Takeaway

In order for any investors to be successful, each have to follow a set of rules as a guideline when making each investment decision. But amount all rules, there are a few that stand out the most, and these are the Golden Rules of investing.

7 Golden Rules of Investing:

  1. Don’t follow the crowd
  2. Invest don’t gamble
  3. Know the value, know the price
  4. Diversify
  5. Don’t listen to expert’s forecast
  6. Invest in what you know
  7. Beware of fear and greed

Rules of profitable investing allows small investors like you to perform well in investing.

But before you can truly become a successful investor, there is something you need to have.

Knowledge

Knowledge is what differentiate a successful investor from a gambler. Successful investors like Warren Buffet is successful, because he have the right knowledge to make the right decision to buy or sell a stock.

Combined with the right investing knowledge and following the rules of investing. You have the potential of getting a nice profit from your investment.

Successful investors like Warren Buffett read approx 500 pages a day.

Knowledge on investment can be learn from books or articles like this one. Reading can only make you wiser and smarter, so that you too maybe able to make the right decision in your investment.

Will Durant Said:

“Education is a progressive discovery of our own ignorance.”

 

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