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Laws Of Successful Investing

Though my investing & trading experience is limited to less than 10 years, which is much less than many other veterans, I’ve decided to compile a basic list of “investing laws” that I’ve come to observe over the years.  I hope you find the list helpful.

1. The market is not a free market – As an individual investor, you don’t have the same advantages of Wall St firms.  There is definitely some level of manipulation in the market and even if it’s not blatant manipulation, with the majority of the daily volume being driven by computers, it’s hardly a normal market.  In order to succeed as an investor, you need to understand how the market really works.  Know that it doesn’t work in the manner that we think or naively hope it works.  Because of these manipulative or computer-driven forces on the market, the market is prone to excessive volatility (for an example, check out the “flash crash” of May 6, 2010).  Additionally, know that politicians want and need for the stock market to remain “high” since so many Americans’ savings and retirements depend on a rising stock market – a market crash is politically unacceptable – read into that how you wish.

2. Accurate economists are often not accurate market predictors – Some of my favorite economists who are typically right on the economy are frequently wrong on their market predictions.  Because of this, be careful making trades or investments based on even the best economists’ expectations of the stock market.  Over the short term, the market can be completely unpredictable.  The reality is that the stock market is often very different than the economy which brings us to the next law of investing…

3. The stock market doesn’t represent economic reality, it represents people’s perceptions of economic reality – This might be the most important point to learn.  People buy (or sell) stocks based on how they perceive the economy to be.  Very often, their perceptions are incorrect, but it doesn’t matter.  It will move the market nonetheless.

4.  Most retail investors lose money investing – The main reason that most retail investors will lose money is because they make their decisions on emotion.  When it comes to investing, your emotions will always tell you to do the opposite of what you should do.  When stocks are down, you panic, and you sell.  When stocks are high, you buy into the euphoria, and buy.  The result is often losing money.  Successful investors have a strategy and they stick to it.

5. Beware what financial experts, financial advisers and Wall St are selling – The main thing here is diversification.  Diversification has been sold to the public as a sure way to avoid losing money.  If you were fully invested in a well-diversified portfolio during the 2008 crash, you know how dumb that idea is.  Understand that Wall St will want you fully invested at all times so that they can generate fees from your invested capital.  Every dollar you hoard in cash, gold or whatever outside of their world means they miss out on a fee generated by that dollar.

6. Beware historic returns – Historic stock market returns are also a major selling point of financial advisers and Wall St.  No matter what is happening in the world, the economy or the market, you should always be buying stocks because historic returns tell you that you will do great over the long haul.  The problem is that the next 50 years might be completely different than the last 50 years.  Also American is not guaranteed to the be the dominant economy for the rest of the history of the world.  Times change.  Powers change.  Economies change.  Don’t forget that.  As such, don’t put all your eggs in the basket of American economic growth for the next 50 years.  Dollar cost averaging and regular interval investing has a place at times, but it is not the end-all solution to wealth generation.

7. Paper profits are meaningless – No matter what asset you’re holding, if you have outsized gains on paper, it is completely meaningless until you realize those gains and take cash.  For a great example, look at the housing bubble during 2004-2007.  Millions of people had paper gains of hundreds of thousands of dollars on their homes, and in a short time period.  Therefore, booked profits are the only thing that matters.  While daytrading or even frequent trading is probably the wrong strategy, taking profits in a position that has run far and high is never a bad thing.

8.  The only thing that is risk-free in the stock market is a dividend that has already been paid – As many investors saw in 2008, even companies with track records spanning 100 years can collapse.  The only sure thing in investing is cash that has already been paid to you.  As such, dividends should be your focus.  If your portfolio is generated significant dividend cash payments on a regular basis, you are consistently decreasing your risk over time since you’ve already earned money on your positions.  Re-investing those dividends appropriately can then lead to even more cash flow.  Remember, to make money on a non-dividend stock, you have to trade it – you have to buy it and sell it, and you have to sell it at a higher price in order to make money.  With a dividend stock, you can earn money by holding it.  Dividend stocks are for investors.  Non-dividend stocks for traders.  Also, dividend payments are vastly superior to stock buybacks in my opinion.  For a great read on why dividends are better, click here.

9.  Stock markets priced in dollars can appear to have better returns – for real return values, price the Dow in gold or at least factor in inflation from your returns.  This overlaps somewhat to being cautious of historic returns, because most people fail to factor in inflation.  You often see a drastically different picture if you look at a chart of the Dow priced in gold versus the usual chart that you typically see.  Is gold the ultimate barometer?  Maybe, maybe not.  But it is a more honest look at your return since a debased currency can often lead to higher stock prices.

10. If CNBC is your source for information, you’re in trouble – I’ve come to despise CNBC over the last couple years.  Honestly, not only is the information completely biased towards a “good” stock market, the information is typically just fluff.  For example, you’ll get a line of “experts” trying to get on CNBC following a 4pm market close to explain why the market went up or down that day.  Often times, they’ll use the same reason for why it went down that someone used to explain why it went up the day before.  It’s complete nonsense.  At best, it’s inaccurate, and at worst, it’s propaganda.  Don’t even turn it on.

This list may change or be modified in the future as yours truly gains more experience and makes (or loses) more money in the stock market.  If you want to see some of the opportunities that I see in the investing world, be sure to check out my Major Trends.