8 Investing Principles Everyone Should Know
The following graph gives an illustration of investing a dollar in different asset classes in the market from 1926 to the end of 2007. The returns and dollar value shown represent past performance only and does not guarantee future results. The red arrow at the bottom indicates when 9-11 occurred. (Photo credit: Wikipedia)
1. Understand What Type Of Investor You Are
A key principle is to understand what type of investor you are. There are either active or passive investors. To be an active investor one must be committed to doing the necessary research in order to generate a good return. They also must learn to manage risk wisely. A passive investor does not have the amount of time it takes to properly research and diversify investments. This type of investor is better off investing in a whole index fund where they can achieve diversity and get the return of the whole index. Another option is to let a professional handle his investments if they do to have the time to devote to it.
2. Buy Low And Sell High
Buy low and sell high is a sometimes overlooked but a very important principle of investing. One needs to consider the value of a security and buy it on sale, below its value. This minimizes the downside risk and allows for maximum gains. In order to properly understand the value of a stock, an investor needs to know PE Ratios, Market Cap, Volatility, Book Value, and EPS or earnings per share. All these things and more are part of the research a trader needs to do to understand the value of a security.
3. Be Ready For Volatile Times In The Market
Be ready for volatile times in the market and learn how to hedge against and even profit during those times. Use volatility to your advantage by finding good investments at bargain prices. Learn how to hedge your investments using options, futures, and precious metals investing. Watch the VIX or Volatility Index to gauge volatility in the market. Bad news and economic data can also effect volatility.
4. Never Trade On Emotions
Never trade on your emotions is a principle easier said than done. Have an investing plan written down ahead of time. This way when bad news and the fear emotion comes along you will be more prepared to stick to your plan. Trading on feelings and emotions almost always ends up as losses. Know your securities and and the fundamental principles of the security. If the company is sound and intact then panic selling may not be the best option. Waiting for a calmer, more sane moment is always a better strategy.
5. Diversify And Preserve Capital
Diversify and preserve capital is the fundamental principle behind all investing. If you put all your funds into one security and it goes down you have no hedge. Spreading funds around by investing in different sectors of the market hedges against them all going down at one time.
6. Allocate Your Assets
Asset allocation helps balance risk across different asset classes. Not just stocks, but also bonds, real estate, precious metals investing and cash. If one asset class does well and another not so well, the one that is performing well will make up for the one that is not. The way you allocate your assets depends on your financial goals, how much risk tolerance you have, and your short and long term goals.
7. Compounding Dividends
Investing with dividends is another useful and profitable strategy many traders use. Compounding investing works over time and the longer you stay invested the more money your money will make for you. When you reinvest the dividends on a regular basis rewarding profits begin to add up.
8. Manage Your Risk
Always manage your risk is a key principle every investor needs to do. Use stops strategically to minimize losses. Understand what you are investing in by doing your homework and research. Don't trade on fear, wait for a more sane moment. Diversify and hedge against volatility in the market. These few basic principles are the foundation of good investing.
Mitchell Gavillion is a long time investor and freelance writer.