The GFC showed how some long-held beliefs about investing do not work, and left many investors wondering what they need to do to be successful. As an investor you may have felt the emotional strain of watching your life savings take a dive as you rode one of the biggest rollercoasters in the sharemarket on record. To bust the myths around these beliefs I want to share eight things you need to do in order to steer clear of the rollercoaster and be successful in your own right in the sharemarket.
Those who take the necessary steps are on the path to becoming financially free. You will learn that the sharemarket is not to be feared if you have the knowledge to enable you to tap into it, starting with these:
1. Buy and hold is not the answer
Investors generally live by the strategy that ‘buy and hold’ is the best way to achieve superior market gains. However, adopting this approach will see gains made during bullish periods decimated when the bears take control, whereas an active approach allows you to participate in the majority of a bullish run and sit on the sidelines to avoid the worst if the market turns bearish.
2. Don’t follow the herd
Many investors react to market conditions by purchasing shares en masse when markets are rising and selling en masse when markets are falling; the old adage that investors buy at the top and sell at the bottom rings true.
3. Learn to ‘read’ the market
I assure you that learning to read the market is not hard and mysterious – those with the right knowledge can adapt to market conditions, which to the learned presents opportunities rather than threats. You could say that learning to drive a car is far riskier, however, regardless of who we are anyone can learn to drive safely.
4. Educate yourself
Ignorance can be very expensive! Many people who told me in the bull market that they did not need or could not afford to learn have now suffered losses many times greater than if they had gained a solid education. When it comes to the sharemarket, your first investment should always be to educate yourself. Ask yourself – if you were someone else, would you give money to you to manage? In most cases I believe your answer would be no.
5. Have a plan as to how you will invest
Did you know that the logical part of your brain is much smaller than the emotional side? In order to make smart decisions about your finances it stands to reason that you need the logical side to dominate, yet the opposite is normally the case once fear or greed set in. This is the main reason why we see otherwise intelligent people employing emotionally driven financial decisions. The way to avoid this is to have a solid plan in place and come up with a strategy to help you stick to your plan.
6. Use stop losses to protect capital
Successfully investing in the sharemarket is not about how much you make, rather it is about how much you do not lose. In other words, it is about minimising risk not maximising profits. Using a simple capital preservation technique, such as a stop loss, will achieve superior returns simply because the portfolio will not suffer large losses and returns are compounded much faster than by simply holding onto falling shares and hoping for the best.
7. Always manage your risk
The amount we invest in the sharemarket tends to change our perception of the risk we are taking and the research required to manage that risk. Usually this is because it is much easier to swallow a $1000 mistake than a $50,000 mistake. But let me assure you, whether you have $50,000 or $1000 to invest the process you take should be consistent, as the degree of risk to your total capital is the same.
8. Keep it simple, don’t over diversify
It makes sense to spread your money across different asset classes, however, when diversifying within an asset class I find that people mistakenly hold too many stocks. My research and conclusions formed by others proves it is wise to restrict a portfolio to hold between five and 12 stocks on average. The benefits are that it is much easier to select a small number of rising stocks, the portfolio is much easier to manage and to top it off you will save money on transaction fees, all of which helps you make more money.
Janine Cox is a Senior Analyst at Wealth Within. She is a highly regarded analyst, share trading educator, mentor and regular market commentator for the ASX, Sky Business and other national media.