To grow one’s wealth, a sound investment plan is crucial. This will ensure that your money works as hard as you do, if not any harder. Rules are basic generalizations that are accepted as true and that can be used as a basis for substantiating your investment decisions. To me, there is really no one golden rule that can guarantee your investment return, without any risk.
For your information, I have compiled a list below that explains the rules in investment. Many of the rules are highly preached and practiced by investment gurus throughout the world. I hope that this set of rules will be able to provide you with some guidance. Refer to this list when you are thinking about an investment decision. This will be a handy guide throughout.
Wondering what you should do with your money or want your money to work for you? Visit this page again and revise the investment rules.
1. Wear your armour before going to war
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In the olden days, before a soldier goes to war, he will prepare his armour and weapons. Although investing is not about warfare, risk is prevalent. By the way, many investors still refer to Sun Tzu’s Art of War for investment strategies.
The biggest risk in life is to lose the ability to earn. Death, diseases, disability, and some major disasters can really hurt your financial standing. Getting a solid foundation and doing some ground work will not only give you a good support, it will also give you the peace of mind that whatever happens, you will not lose all your hard earned money.
Without proper wealth protection plans, no matter how good your investment returns are, your money can be wiped out instantly. (unless you are Bill Gates or Warren Buffett). Investment returns need time to realise, but insurance returns are immediate when you need it the most.
Wonder how to properly manage your risk in life, refer these articles:
- Do you need Insurance Switching?
- Everything about Life Insurance Company in Malaysia
- How Much Critical Illness Insurance Cover do you Need?
- Investment Replacement Feature in Investment-linked Policy that Beat Unit Trust
- Life insurance is CHEAP?!
- Top 10 reason to buy life insurance
- Types of Life Insurance Benefits
- When Should We Review Our Life Insurance Coverage?
2. Net Worth Mentality instead of Paycheck mentality
Net worth is what a person is really worth, minus the liability from his/her total assets. Remember that net worth is the measure of how wealthy one is. It doesn’t matter how big your paycheck is. If there is nothing left at the end of the month, it means you’ve got nothing for investment.
The basic requirement for investment is to have saving to do that. You need capital.
3. Start now! Otherwise, you are still not in the game
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Experts and financial advisers have been repeating many times that you need to take investment actions now. Please start investing as YOUNG as possible, as EARLY as possible and as SOON as possible.
For instance, imagine if your grand-grandfather bought you a piece of land 100 years ago. Would you still need to work today? Would you have become a millionaire?
Money needs time to get compounded and start working its wonders. Start investing now! Don’t procrastinate.
You should set aside all your free savings available, for investment. Invest now in lump sums, according to your choice of asset allocation and portfolio.
4. Regularly inject your saving into investment
Once you have invested your savings, get your monthly positive reserve invested as well. Do regular top up.
Dollar cost averaging is a very useful strategy in this case. Your capital will grow faster than you can imagine.
5. Know what you are investing
This is one of Warren Buffett’s rule of investing. He only invests in companies that he can understand.
If you put enough hard work into doing your research, you will have the confidence to invest in something you have studied.
If you are not interested, get a sincere adviser to explain to you. Even if you are very lazy and don’t want to learn those stuff, bank on mutual fund, unit trust, or investment-linked funds. Such modes of investments are highly suitable for passive investors.
6. Most of the time, simple is better than complex
If something is complex, any variation would require more work and a longer time to make decisions. Simple plans are normally the best. Consider the example below quoted from TheStreet.com
Start with a few million mortgages of varying credit-worthiness and create a series of residential mortgage-backed securities (RMBS) from them. Then take the RMBS and stratify them. Then leverage them up into collateral debt obligations (CDOs). Once that bundling is complete, make complex bets on which layers might default, via credit default swaps (CDS). Gee, how could anything possibly go wrong with that?!
In fact, plenty can go wrong in a long, and winding process. If something is too complicated, I guess you won’t understand it anyway. It already contradicts with the rule: “know what you are investing”
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There’s an old saying – Don’t put all eggs in one basket. It doesn’t mean that you should put all your money in one asset class. You can do that, but just diversify. If your money is in stock market, diversify into different countries, regions, sectors etc.
If your investments are property-related, spread the investments in different locations.
If you have invested in your business, then spread it across different customers instead of one major client.
In website monetization, then diversify across various money makers (AdSense, affiliates program, Text-link-Ads, direct private ads etc.)
8. Find the right asset allocation
Asset allocation depends on your investment horizon, investment objectives, and risk tolerance.
If you can’t sleep when there are major business news that affect your stock performance, it is better to keep out of the way.
If you need a moderate return, stick to a balanced portfolio.
While you are young, take advantage of higher equity exposure to reap potentially higher returns.
A good portfolio consists of different asset class that correlate with each other. When one goes down, the other one may go up and negatively correlated. It will eventually cancel off the risk and produce safe return.
9. Minimize investment cost
If the entry cost is too high, the investment needs to have the highest potential to give you high returns. If you want to invest in unit trust, learn to minimize your transaction costs, such as switching instead of repurchasing your funds. Refer to some of the strategies I shared before.
I am sure that every kind of investment has its own tricks to cut the investment cost to the lowest. For example, buying a residential house below RM250k in Malaysia entitles one for a 50% stamp duty discount. Buying shares in lots of less than RM1800 is going to incur higher percentage of broker fees.
Learn to minimize the cost and attempt to recoup the commission, fees, and charges lost in the process.
10. Tax saved equals return gained
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If you invest in something that gives you tax advantages, it is similar to getting high return from you investment.
For example, you buy unit trusts that give you 10% return p.a. in order to fund your child’s education. At the same time, you are paying 27% income tax on your employment salary.
You can opt to buy an education policy, or put the money in SSPN account, which immediately gives you 27% return from tax deduction, even though the financial tools itself only generate merely 5% return. But 5%+27% is 32%, which is much higher than your unit trust investment. Moreover, the tax saving is guaranteed, as long as you meet the terms and conditions.
11. Only time the market if you are not afraid of having heart attack
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I never time the market.
According to Benjamin Graham (1894-1976), investors should not try to time the market, as the stock market movement is always unpredictable. When timing is crucial in your investment strategy, can you imagine yourself looking at your investment performance almost every hour, if not every minute?
When stock performance is like a roller coaster ride, your heart rate is bound to pump up and down. Beware of getting a heart attack. I know some people like the adrenaline. Betting on timing is similar to driving fast sport car. Whenever you hit the right corner, you make a great gain without reducing the speed.
If you enjoy the roller coaster ride, just use a small portion of your portfolio allocated for extreme trading. Probably 10%. You get the joy when your prediction is correct. Your overall return will never be hurt if the prediction goes sour.
If you are no genius or psychic, don’t ever time the market.
12. Past performance is no guarantee of future performance
Great past performance provides you a reference. That’s not a guarantee of future gain. Some unit trust funds perform extremely well on this year, but go south the next. So never rely solely on past performance. Do your research instead.
13. Rebalance your portfolio at certain frequency
During the economic cycle, some asset classes perform better than the other. So at certain point, your portfolio will be out of balance.
For instance, during a stock boom, your equity funds perform better. Whenever that happens, sell off some equity investment and put it in other asset classes that are not performing as well as stocks. This is the basic principle of making return. Buy low, sell high.
Regularly rebalance your portfolio when necessary.
14. Filter out the “noise” about the market
Analyst and some so-called experts publish critics and forecast about the market even though there is nothing to say. Don’t fault them as they are just doing their job. They are paid to write something.
Most of the time, when a major news is announced, you are probably too late to act on it. Don’t let the market sentiment affect you. Stick to your own research and believe in yourself.
You are your own money manager after all.
15. EQ (Emotional Quotient) proportionate with return
Never panic. You won’t get it right if you are in state of panic. Some major players make big profit from irrational actions by small investors.
Stay calm, think and act accordingly.
16. Don’t lose money
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This is the first rule of investing by Warren Buffett – don’t lose your money.
The second rule is – don’t forget the first rule.
17. Don’t attempt to make a quick buck
This is called gambling. Most often the attempts to make a quick buck lead to losing a lot.
18. Cut your losers;let your winners ride
At the end of the day, your investment decisions have to add up to more wins than losses. Set your cut loss margin lower than your lock gain margin. For example, if you decide that you will cut loss if the investment reach -10%, follow your rule and cut the losers. Your theory leading you to buy that investment might be wrong.
This rule is especially important if you are involved in trading your investment, such as FOREX trading and stock trading.
Another mistake is cutting your winners. When your investment goes up in value, you are doing the right thing. Let it goes up further until it reaches the point where your research shows that the investment in question is too highly priced. When that happens, you should lock your gain.
People have been trading the markets for 160 years. Cut your loses short and compound those winning positions.
19. Buy and hold is not fool-proof strategy
Buy-and-hold investing is when a person buys a stock and they intend to hold it for a while without selling it, usually at least 1 year. But most buy-and-hold investors hold their stocks for 5 or more years.
In general, it’s a “stick with a good company” approach. Buy-and-hold might be true in real estate investment, provided you bought the right property at the right location. But this is not a fool-proof strategy. That’s why we need to revise our investment portfolio from time to time. Some investment might not be as good as it used to be after years of holding it.
20. Analysts recommendation is not always right
They are just doing their job. Humans make mistakes too. Verify the analysts’ reports and decide on your own.
If you read Personal Money Magazine January edition, there will be a column showing you top 10 stock picks by different fund managers. After a year when you review their recommendation, not every stock recommended is making money, even though the Bursa Malaysia market had risen 37% in year 2007.
Your own judgement is your best reference. Make sure you study the market and do ample research. Otherwise, stick with passive investment strategies using unit trusts or mutual funds.
21. Manage investment risk : reward-to-risk ratio at a minimum of 2:1
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Reward-to-risk ratio is used by many investors to compare the expected returns of an investment to the amount of risk undertaken to capture these returns. This ratio is calculated mathematically by dividing the amount of profit the trader expects to have made when the position is closed (i.e. the reward) by the amount he or she stands to lose if price moves in the unexpected direction (i.e. the risk).
Let’s say a trader purchases 100 shares of XYZ Company at $20 and places a stop-loss order at $15 to ensure that her losses will not exceed $500. Let’s also assume that this trader believes that the price of XYZ will reach $30 in the next few months. In this case, the trader is willing to risk $5 per share to make an expected return of $10 per share after closing her position. Since the trader stands to make double the amount that she has risked, she would be said to have a 2:1 risk/reward ratio on that particular trade.
If you are an active trader, don’t forget this rule.
22. Sometimes, idling is better than trading
Great picks doesn’t come everyday. Again, this is an important investing rule for traders.
23. Never borrow money to buy stocks
When you get into debt and buy stocks using margin trading, you limit your options. When things go south, you get trapped into your original investments. All stocks can crash. If you are high in margin, you will soon have a margin call in which you could lose all of your money.
24. Getting good debt to serve your property investment
Intelligent investors buy property with the lowest down payment that’s possible. They use leverage to own more properties. But make sure you find someone else to serve your loan installment. This can be done by looking for reliable tenants.
How do you know if it is a good debt? When you are not the one to serve the debt installment, that’s a good one.
25. Company with zero debt has never gone bankrupt
Investing in debt-free companies might be safer than putting your money in Fixed Deposit. Banks may go bankrupt too when its clients fail to serve the installment. But we have never seen a zero debt company go bankrupt before.
26. Buy damage stocks, not damaged companies
This is one of the rules in Cramer’s 25 rules of investing.
In 1998, when Cendant was defrauded by the management of CUC International through a series of bogus financials, the stock went from $36 to $12 in pretty much a straight line. Was that a one-day sale that should be bought? No, that was a damaged company. It took years for Cendant to work its way back into the hearts of investors. Some say it has never recovered.
But when Eastman Chemical(EMN) announced a shortfall in early 2005 because of a problem — a fixable problem — at one of its facilities, that 4-point dip was a classic panic sale, one that you had to buy. The stock subsequently moved up a quick 8 points when the division recovered in the next quarter.
27. Enjoy the learning process
In order to enjoy all the time during your investment horizon, you should be excited about new stuff you learn about investing. Practice what you just learned.
28. Love your investment
Investment involves buying some assets.
If you like properties, learn about property investment.
If you like stock, learn about reading public companies financial reports.
You use your hard earned money to buy those assets, in the hope of gaining appreciating value from it. If you don’t like that asset, that is very miserable.
For example, a webmaster may love seeing his website, or web apps doing well, getting increasing traffic, and being ranked high in search engine. It really make sense for him to invest most his money into acquiring “internet real estate”.
You just got to love what you buy. Otherwise, why bother to buy it anyway.
29. Flexible enough to change course when necessary
You must be flexible enough to change your investment strategies as and when the financial need arises.
Investments are volatile and fluctuate according to the economic climate. As such, moving funds around will help you save if not grow the existing amount of money you have invested.
30. Mistake had to be small, but still give you a lesson
Some investing mistakes are very disastrous.
Imagine buying that property straight from developer and the project is abandoned half way. You still owe the bank money, but your real property is not yet “real” (built). This kind of mistake will cause permanent damage and hit your cash flow badly. These kind of mistakes can be devastating to your financial being.
The rule is to start small. Learn from small mistakes so that you will know what to do when making major investment decisions.
31. All investments have their pros and cons
There are the good and bad in every investment. When you are investing passively in unit trust, the transaction cost is much higher than buying the company stocks directly. But if you have the expertise behind doing all the number crunching and analysis, then you will be able to make a sound investment decision.
Real property investment might provide potentially higher returns than other investment because of the leveraging effect. However it doesn’t provide high liquidity compared to stocks or mutual funds. Selling your real property takes time to get the right willing buyer who can afford it.
You must know how to deal with the pros and cons.
32. Everyone has a magic formula
After years of training, learning, and investing experience, you will ultimately make up your own set of rules, which is the magic formula. Congratulations to those smart and hard working folks who already found his magic formula.
However, one’s magic formula may not suit everyone. You must find one that suits you best.
33. Let your return compound!
Compounding effect is the 8th wonder of the world, according to Einstein. If you spend your return from your investment, the wonder effect is lost.
Always inject your returns back to your investment – let it compound and it will grow fast.
34. Find good bargain
Possessing ability to find a good buy puts you in advantage.
If you bought the investment at a discount, you are one step closer to making a gain. A good bargain provides a better margin of safety. Say you buy a house that is 10% lower than the usual market price. You already earn the difference even if you manage to sell it immediately. Good bargain takes time to find. Good bargain normally available in property auction or foreclosure.
Warren Buffett also buy good stocks and companies that is undervalued by the market, according to his own research of course.
35. Time is greater than money
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You can never buy time. Don’t let time slip away. If the money you get from an investment is not worth the time you are putting in, walk away.
36. Focus on reducing risk, returns will eventually come
Some high gain investment can also mean high risk. But you learn how to minimize the risk, and the returns still remain high. That’s the key to success.
Constant learning and through years of experience, you will learn how to minimize the odds of losing money.
37. To invest is to defer
Whenever we decide to invest, its in effect a decision to defer the capital for later consumption. It is a good sign. Without deferring, there will be no savings. No savings would mean no capital for investment.
In other words, to invest is to defer current gratification in exchange for future rewards.
38. Know your time horizon
Time horizon play an important role in investment strategy.
If you are accumulating wealth for retirement 20 years later, you can have a higher exposure in higher risk asset classes such as property and stocks.
But for a retiree, it is crucial not to risk his capital. Therefore, his investment porfolio might consist more of fixed income asset class.
39. The most important rule of all: Invest in your expertise!
When you concentrate on certain investments, be it your own business, or in real property, or stock market, through years of study you will become an expert.
Imagine you are in the restaurant business. Every RM100,000 you have as capital, you know you can open up another restaurant. Just by putting 1-2 months effort, you know that you will be able to turn it into a cash cow giving return as high as RM50k profit a year which is equal to 50% annual return. It really makes sense that you invest all your money in your business solely!
Yes, diversification is highly essential. You can diversify in terms of location, in terms of countries, in terms of business plan, in terms of size etc.
When you have become an expert in a certain field, making money from your investment is just a piece of cake. That’s why the rich become richer. They have been there, and done that. They just need to repeat their success stories.
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