19 investing secrets everyone should know before investing

Editor’s note: This article was first published in July 2014. Its point 19 refers to Amancio Ortega and Bill Gates as the people running Inditex and Microsoft, as of 2014.

If I had to teach a course on investing for beginners, these are the starting points I would begin with, before going into more detail on each and every one of them.

1. There is no magic formula, and it is not so easy that anyone can make money from it. Investing takes hard work researching and analysing the industries and stocks we are going to choose.

2. Most people never quite grasp the difference between price and value. A share at 0.10 euros can be far more expensive than one at 500 euros. As Benjamin Graham put it: “Price is what you pay; value is what you get.”

3. A good investor usually has a better grasp of psychology than of economics. Knowing the biases that interfere with our investment decisions is an advantage over any analyst or economist.

4. As in any business, you make more money when you buy than when you sell. It’s not about what you buy, it’s about what you pay for what you buy.

5. Margin of safety is everything. Getting in when a stock is extremely cheap gives you priceless peace of mind when, much higher up, the stock is struggling to break through technical resistance levels. With a reasonable margin of safety, your doubt will not be whether to cut a loss or not. It will be whether to take your profit now or not.

6. When you speculate based on what a stock ought to do given events, you should know that the market, the stock and investors can stay wrong for longer than your pocket can bear. (Keynes said this.)

7. In the fight between bulls and bears, be aware that however you reasoned as a bear or a bull when taking a position, on the other side there is someone probably just as smart as you, or smarter, who has reasoned the opposite way and is sure they are better informed than you.

8. The most successful investors tend to be contrarians, while the rest either lose money or insist that the logical return on investment is 8% a year. Staying away from popular opinion has historically given excellent results and higher returns.

(Read: How Warren Buffett analyses stocks before investing)

9. The only certainty in investing is that there is no certainty. Equities are variable income, so there is no such thing as a safe investment, however sure we feel. Even so, you have to take risks if you want high returns, but always with humility, never from a position of perfection, because you are not perfect.

10. There are many risks in investing, but the biggest risk you need to protect yourself from is yourself. Recognise your weaknesses and limitations.

11. Holding cash with no plan to invest it (in fixed or variable income) carries more risk than investing the money. Don’t underestimate how quickly money loses value when it is exposed to inflation.

12. You should know the 3 most profitable types of investment there are:

Stocks are more profitable than bonds, while real estate has generated more individual wealth than stocks.

• Bonds: they tend to have a good return/risk balance (they are fixed income). The risks are very low. Bonds represent a financial obligation of a debtor (usually a government) to pay the bondholder within the agreed time.
• Stocks: they represent a share in the ownership of a company and a right to receive part of its profits as dividends, plus the added appreciation of the shares as the company grows and increases its turnover and profits.
• Real estate: it represents the ability to use a space, where the property’s appreciation would generate a profit if it is sold at a later date.

Note: the problem with real estate is that, as a general rule, you need a lot of money to invest in it, since investing in property with a speculative aim does not mean buying with a mortgage and waiting for the property to go up in value.

(See: The most profitable portfolio diversification for financial success)

13. Diversification is not always advisable when investing. It depends on how much money you want to put to work:

• If you have a large amount of capital (over 1 million euros), you should diversify into large stocks with low volatility that pay good dividends. Probably with a percentage in bonds.
• If you have a medium amount of capital (90,000-300,000 euros), you should diversify by putting one percentage into low-volatility dividend stocks and another into stocks that could be considered investment opportunities. Perhaps even a small part into riskier stocks.
• If you have a small amount of capital (5,000-10,000 euros), the point is not to aim at anything that moves, but it is not to diversify either. It would probably be a good idea to put all your eggs in one basket, or perhaps two.

14. Clearly, before taking on these diversification tips, we need to analyse our investor profile and how much risk we are willing to tolerate.

15. Don’t make any buying decision if you haven’t looked at the stock’s chart first, or if you have trouble understanding the chart. You don’t need to understand technical analysis, but you should at least know enough to see where the stock is coming from: where it was, where it is, what its highs and lows were, and what resistance levels it will run into.

You can see the most common chart patterns here (part 1) and part 2.

16. Remember something investors forget in the excitement of taking profits: the real return on an investment is what you collect minus taxes. In other words, your net profit is much smaller than your pre-tax profit. Many people are surprised afterwards.

17. Investing is not a game. If you treat it as a game, you will lose. You don’t go into the stock market to try your luck. You go in to earn a return on your money.

18. In investing, a little knowledge can actually be worse than complete ignorance. Reading a book about Warren Buffett’s investment method doesn’t make you Warren Buffett. Before you throw yourself into investing, try to become, if not an expert, at least a competent investor.

19. Approach investing from a business owner’s point of view, not an investor’s point of view. The stock market lets you finance Amancio Ortega (Inditex) or Microsoft. Find a company you would like to have a stake in and become a partner in it by buying part of the company. Bill Gates or Amancio Ortega will give you part of their profits. That is smart stock market investing: it means we finance companies and activities, and we get paid for it.

Featured image: Eva K. / Eva K., CC BY-SA 2.5, via Wikimedia Commons.