After a horrible January for the stock market, investors are understandably nervous, if not scared. It is never easy when markets are in retreat, but retreat they do. There is no certainty when it comes to investing. There is only process and discipline to guide us through there tumultuous periods. So, I like to revisit the basics that keep me out of trouble and focused on opportunities.
First and foremost, Never Invest in Something you don’t Understand. That rule has saved me time and again, especially during the Enron and Worldcom era as I had no clue as to what those two companies did.
Secondly, Avoid any Leverage, as it can easily turn a good investment bad, shorten your staying power and cause significant losses.
Thirdly, Be Contrarian. I know all too well that in times of stress this is very difficult to do. I rely on Warren Buffett for guidance. “Two super contagious diseases, fear and greed will forever occur in the investment community. The timing of these epidemics will be unpredictable. We simply attempt to be fearful when others are greedy and to be greedy when others are fearful”. This is the simple recipe for being a contrarian investor.
Fourthly, Be Patient and wait for the Fat Pitch. Many investors suffer from an action bias, a desire to do something. However, when there is nothing to do, the best plan is usually to do nothing. Stand at the plate and wait for the fat pitch and in this downturn they are starting to appear.
Fifth, This Time is Never Different. What we learn from history is that people don’t learn from history. When investors get either too fearful or too greedy, they sometimes hide behind the notion that “this time is different”. Usually, they regret it.
Finally, Always insist on a Margin of Safety. Valuation is the nearest thing to the law of gravity that we have. It is the primary determinant of long-term returns. So, our objective is to buy at a price level that provides a cushion against errors and misfortunes.
During the 5 decades from 1964 through 2014, the S&P 500 Index returned 11,196% including reinvested dividends. During those years, the value of the dollar (cash) fell by 87%. If you owned US bonds during those years, yes, you earned a safe rate of return, but you ultimately lost 87% of the purchasing power of those invested dollars.