Good, tried-and-tested investment rules enable you to develop effective strategies and tactics. If you want your investment to flourish, internalize the 12 golden rules of investment and make them part of every endeavour.
Before you start investing, it’s good to spend some time on preparation. Investment is kind of like the crown of personal finance management. To better explain it, I have prepared “A pyramid of personal finance management”.
The foundation of all money management is budgeting. A well-prepared budget for every month in the shorter term and then every year, or 2-10 in the medium and longer term respectively is an essential framework for your finances. It enables you to act rationally. It helps to navigate through the complexities of life straight to your key financial goals, whether they be big or small.
The next level of the pyramid is saving. Everyone who wants to be successful in finance, whether personal or corporate, must be able to save money. Saving money needs to be a habit, a default behaviour, being the lion’s share of your financial decisions.
The third level of personal finance is debt management. Because of the nature of modern finance, everyone should know how to deal with debt, how to manage debts well, and of course how to get rid of debt.
When you have experience of budgeting your money, when you have savings, -ideally as an emergency capital equal to 3-6 months of your normal earnings- and you have paid your debt off, you can start planning your investment. This is level 4 of personal finance management.
While preparing for investments, you certainly have to understand the value of delayed gratification If we could imagine an ideal model of an investor mindset, this would be a key feature.
When you invest, you sacrifice your present comfort in order to bring prosperity in the future. It takes faith, patience and self-discipline to do that. Most of us don’t want to even think about it. The majority always want to have something now, and pay for it in future. That is why societies in developed countries are sinking in debt.
I would also strongly recommend taking into account all kind of biases we humans have developed which can stop us from making proper investment decisions.
Wikipedia identifies 104 biases.
There are four categories of cognitive biases.
The first is a result of too much information: you can’t actually make a rational decision if you are not able to process all the available and relevant information.
The second group arises from not enough meaning: even if you gather all the relevant information, most of time you may struggle with assigning them a proper meaning. This the moment when we can use stereotypes, previous experience and preconceived beliefs to aid our decisions.
The next group contains biases which are a result of our memories. The way how we remember things, how we omit some facts and construct reality makes susceptible to another kind of biases.
And the last group contains biases which are a direct consequence of lack of time. If you have to make a decision now and you can’t wait until all research and analysis are made, you will have to act by choosing simpler solutions over the more complex ones. It is easier and faster to comprehend one simple option than an option which is complex and requires more cognitive power.
I want to draw your attention to the 5 dangerous biases in investing.
The “It has always been like this” bias can annihilate your investment if you believe that there is an incontrovertible link between a past and a future. You might have earned money ten times in an identical situation, but it doesn’t give a guarantee that the eleventh time will be the same.
The “Titanic bias” occurs when you start understanding that you’re losing money, however, you were persuaded that your investment is so awesome that it will certainly be worth it in the long run. You don’t want to face reality, so you might ignore it hoping that a bit more time will change something. Some of the passengers on The Titanic believed that the ship was unsinkable. After the ship hit the iceberg, they still behaved as if nothing happened.
The confirmation bias can be a logical consequence of the previous bias – the Titanic one. When you are losing money, you can find hope in socializing with other people who are experiencing exactly the same. It is probably easier to build a collective illusion.
The relativity bias happens when you pay too much attention to what other people’s experiences are. We all have a tendency to make our individual experience objective. If I never earned solid money in the food industry or media industry shares, I might try to persuade someone that it doesn’t make sense to invest in these industries. If I earned my first big money after the two lousy years, I might think that this “how it is”, that everyone should expect the first 24 months to be poor etc, etc.
The “Know-it-all” bias is a characteristic for successful investors. Someone who has made plenty of lucrative deals might think that he or she is an all-knowing, omniscient individual. Be careful, this is an unbelievably dangerous bias.
After a careful and thoughtful research stage, you can move to the preparation stage, when you will start to implement the 12 rules of investment.
#1. Have a good plan.
The financial plan of every investment is the tool that maximizes your potential profit and minimizes risk. Depending on how fast you need make a decision and how complex your investment is, you can elaborate a detailed and accurate plan or simple plan. For instance, when you prepare for your first real estate transaction or make a quick one page calculation while buying shares for a company you’ve been doing business with for ages. But even if things seem to appear easy, it’s good to challenge your preconceived opinion and keep a fresh perspective on every decision you make.
#2. The right time is now.
If you still don’t know when to start – start now. It’s not very wise to prepare until everything is perfect, because conditions are never ideal. Do you want to really invest and multiply your money? Start preparing now. The earlier you start, the faster you will be reaping the benefits.
#3. Start with something small.
There is one great strategy to start with. Start with a simple investment. Treat it as a testing ground. See how your rules work. Draw conclusions. Make adjustments. Improve. And then prepare for bigger profits.
#4. Understand what you do.
You can’t manage or improve something that you don’t fully understand. So before you start, gain knowledge about the subject of your investment. Speak with other investors. Read articles and books. Attend networking meetings. Ask a lot of questions.
#5. Determine your acceptable level of risk.
Check your previous life decisions to find out what kind of person are you. Do you like challenges and feel comfortable with high risk, or do you shy away from risk, always pursuing a safe environment? It’s worth making some simulations and asking someone to give you a few coaching sessions.
#6. Find out what to invest in.
Do you like real estate? Maybe you always dreamed about gold and precious metals? And how about art, investing in those great Renaissance and Baroque geniuses or even the masterpieces of contemporary artists? And how about financial instruments? Do you feel your pulse is increasing when watching business news and financial charts? There are also startup companies who created their own industries with a specific language, and even dress code. Every type of investment requires a different approach. Discover what you really enjoy and what you can study with enthusiasm.
#7. Keep it simple.
When you write a book or make a movie about investment, you can intentionally complicate things to make them more attractive to an audience. But when you act, you must implement clear and simple rules. Always seek clarity on everything you do. Clarity will help you make quick and simple decisions.
You have to be productive in your investment works and effective. Automation is of the best answers for complexities of modern financial markets and businesses. Use smart software to analyse data. Use automation software to make your decision process more efficient.
#9. To diversify or not to diversify?
This is an absolutely essential question you need to find a good answer to. The general rule is to diversify but moderately, with a sense of proportion. For instance, Warren Buffet has a few favourite industries he invests in, like insurance, banking, media, and consumer goods. If you focus in your investment on a few industries, at the same time you make your business diverse enough to gain more & protect against losses, as well as always being able to understand what’s going on in areas of your choice.
#10. Go against the herd.
If someone is giving you investment advice in a popular newspaper or on TV, just ignore it! The real gain is for a small minority only. Rely rather on expert knowledge, not popular tip-offs.
#11. Never invest money that you can’t afford to lose.
This parameter of your investment protects your business against losses too big to handle. Your business should run smoothly and be managed evenly and rationally. Investment business is certainly not about gambling. It is about gradually multiplying your assets.
#12. Focus on value, not price.
Prices are temporary, but values are eternal. Prices usually depend on values. If you are able to recognize the real value of your investment, then you will never pay too much or too less. Prices are often a matter of speculation, while values are built on passion and dreams to make a difference. Most of the time it’s good to ignore facades, diligently prepared by PR agencies and know what goes on backstage.
In addition to these 12 rules, there is another priceless rule: try Betterment investing in yourself; in your knowledge, experience, skills and emotional IQ.
And you know what? There is one more thing: sometimes in order to succeed you will have to break rules. Life, just like business and finance, is complex and sometimes requires a totally fresh approach.
This article was written by Andrzej Manka, founder of The Financial Manifesto – a project dedicated to making your money work for you.