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THE SEVEN GOLDEN RULES
Being successful at anything requires following a set of rules. Good rules are the accumulation of decades of wisdom summed up into the few components that really matter. Successful football players win because they avoid penalties and because of the way they train. Successful students get A’s because of the way they study.
Investing in the stock market is no different, except that when you succeed in investing you make money, a lot of money. Take Warren Buffett for example; he started out with $10,000 and turned it into a net worth of $60,000,000,000 (That’s 60 BILLION!) . But he’s not alone. Peter Lynch, Bill Ruane, Walter Schloss, Bill Miller, Charlie Munger, Joel Greenblatt, and many others generated similar extraordinary investment returns, consistently, over a long-term time horizon. Each successful fund manager’s style was slightly different, but if you study them each carefully you’ll start to see significant patterns. We summed these patterns into Seven Golden Rules.
So, without further ado, here are the Seven Golden Rules of Successful Investing that will guarantee that you crush it in the stock market.
RULE #1: THINK LONG-TERM
Trying to time the stock market or risking it all to “double your money in a year” is at best speculating, at worst gambling. You may as well just take your money to Vegas and lose it there. Those who are able to successfully navigate the stock market are not speculators or gamblers, they are investors. Investors know they can beat the market because they think differently, they think smarter, and they think longer-term.
“Time horizon arbitrage” means that if investors learn to think long-term and can see beyond the daily and quarterly noise, they can gain a real upper hand. In 1964, American Express was a great company but the stock was getting hammered due to an insurance scandal. The company had to pay millions of dollars in fines due to accidentally underwriting barrels of vegetable oil that turned out to be water. That is exactly the time when Warren Buffett began purchasing the stock. The best investors look beyond short term distress and keep their eyes on the long-term horizon.
“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” Warren Buffett
RULE #2: GOOD COMPANIES MAKE GOOD INVESTMENTS (DITTO FOR BAD COMPANIES)
People need to understand that investing is not like placing a bet on whether the Cowboys will cover the spread against the Packers in the big game. Investing is not trying to get the quarterly press release a microsecond before the other person. It is not even about trying to predict which stock that you think will go up the most. Fundamental Investing is buying a tangible piece of a business, or a share of that business. And your investment portfolio (the collection of all the different shares you own) is only as good as sum of the companies in that portfolio.
If you buy shares of high quality companies at reasonable prices, you’ll end up with a high quality portfolio with less risk. It’s as simple as that. Good companies are ones that have a unique advantage that others can’t copy. Good companies are ones that generate high returns on capital. Good companies don’t need to borrow a lot because their business is self-financing.
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price” Warren Buffett
RULE #3: BUY WITH A MARGIN OF SAFETY
Nearly every professional investor began his career reading Benjamin Graham’s The Intelligent Investor. Warren Buffett called it, “by far, the best book on investing ever written.” What makes it so special? One of the reasons is because it introduced the important concept “margin of safety.”
In investing, a margin of safety is formed when one buys an investment at less than its value, while using conservative assumptions. The idea of a margin of safety is that you want to buy a business at a price that is low enough that your assessment could be completely wrong and you wouldn’t lose much.
“Heads I win. Tails I don’t lose much.” Mohnish Pabrai, Dhandho Investor
RULE #4: DO YOU OWN HOMEWORK AND OWN WHAT YOU KNOW
There is no substitute for your own work. Buying a stock because CNBC recommended it, or because your uncle recommended it, or the stock chart looks good is a sure way to lose money.
Successful investors know what they own. They buy stocks of companies with products they believe in. Successful investors go the extra mile to analyze the financials of the company to make sure they’re not missing anything. Remember, most of the extraordinary gains made in the stock market come after a stock is punished or after it has already risen a lot, but you’re not going to have the conviction to stick with it unless you really know the company.
“You have to know what you own, and why you own it.” Peter Lynch
RULE #5: DON’T FOLLOW THE HERD, STAY CALM AND RATIONAL
The typical buyer’s decision is usually heavily influenced by those around him: buy when others are buying, sell when others are selling. Unfortunately, this is a recipe that is bound to backfire. The best investors are ones that can fight this urge, remain calm through a storm, and remain on the sidelines through a bubble.
The world’s greatest investor Warren Buffett said it best, “Be fearful when others are greedy, and be greedy when others are fearful!”
RULE #6: DON’T PUT ALL YOUR EGGS IN ONE BASKET, BUT DON’T HAVE TOO MANY BASKETS, EITHER
Diversification is one of the most critical strategies for your portfolio so that if one stock blows up, it won’t sink the entire ship. As much as we think we won’t make a mistake, we will. Even the masters do and that is why we can’t put all our eggs in one basket. There’s power in diversification.
However, research suggests that 90% of diversification benefits can be obtained in most markets with a portfolio of just over 20 stocks. The more you diversify beyond that, the less you know about each investment (See Rule #4). Your first and second best ideas are always better than your 100th best idea, so while diversifying is crucial, make your best ideas count!
“We try to avoid buying a little of this or that when we are only lukewarm about the business or its price. When we are convinced as to attractiveness, we believe in buying worthwhile amounts”. Warren Buffett
RULE #7: NEVER STOP LEARNING
Perhaps the most important rule is learn, learn more, and then keep learning. The fun thing about investing is that the markets are always different and companies are constantly changing. Never stop learning about businesses, never stop learning from other great investors, and never stop learning from your own mistakes. Humility and an eagerness to learn are two traits found in all of the great investors. Even Warren Buffett credits his partner Charlie Munger with teaching him that it’s better to buy a great company at a fair price than a fair company at a great price.
“The game of life is the game of everlasting learning. At least it is if you want to win.” Charlie Munger
8TH BONUS RULE WHEN YOU MAKE A LOT MONEY, FIND MEANINGFUL WAYS TO GIVE IT BACK.
Bill & Melinda Gates took their fortune and lifted millions of people out of poverty through their foundation. Warren Buffett has done the same with his billions. If you make millions or even billions of dollars through the concepts taught by YIS, we hope that you will take it and make the world a better place. At YIS, we believe it’s possible to really make our investments count. That’s why we’re investing in you.