Dallas Mavericks owner Mark Cuban wrote an article on the best investment advice he's ever received. It's both great counsel, and a good reminder of how to invest. Here's my take on his advice:
1. Pay off debt
Seriously, pay off your debt. If you have any credit card or other debt on which you pay 5% or more interest, pay it off. When you decide to invest in the market and you have debt, you are implicitly saying that you believe you can earn higher returns than the amount of money you could save by paying down your debt.
Over the years, I have come across too many misguided notions about debt. (Oh, I thought your credit score gets better when you keep a balance on your card! Wait, my credit is hurt when I pay for a Vegas vacation on a new card, and then pay it down over the next year?) Pay off your debt.
2. Cash is king
With interest rates so low, many people have a problem with the idea of holding cash. They struggle to locate the highest-yielding CDs, all so they can earn a few hundredths of percent more than nothing.
Some are going further, letting themselves get lured in by companies' sporting absurdly high dividends, such as Chimera Investment (NYSE: CIM ) and American Capital Agency (Nasdaq: AGNC ) , without understanding the risks associated with these companies. They're just mesmerized by the yield.
Snap out of it!
By stretching for yield, you lose the flexibility that comes with holding cash. That flexibility is worth far more than the meager interest payments you would receive elsewhere, or the risk you take with the high-yielders.
Furthermore, as Berkshire Hathaway's (NYSE: BRK-A ) (NYSE: BRK-B ) Warren Buffett stresses, invest with a margin of safety. Buy stocks below their fair value, and you'll gain even more upside when they rise. This idea extends to your personal life as well: Live with a margin of safety by keeping a cash reserve of six months' living expenses.
Nature understands the idea of having a margin of safety. Why do you think we have two lungs and two kidneys? Living paycheck to paycheck is like living with only one of each. You can do it, but if you ever run into a problem, you're dead.
3. Cash creates transactional returns
Smart shopping will consistently earn you a better return than the market. Say you know you need to buy a new car this year for $20,000. Saving 15% on that car purchase is worth more than earning 15% on a $20,000 investment. Since your investments are taxed and your savings are not, your after-tax earnings from the investment will be significantly less than the $3,000 you saved by shopping. Just make sure you don't then go out and spend that extra $3,000 on something frivolous!
4. Keep learning
Stay curious. There's no age at which you're old enough that you don't need to learn anymore. Warren Buffett has succeeded by being a learning machine. Learn from your mistakes and others', and don't let those mistakes compound. It's almost absurd how much high quality information is now right at your fingertips. Take advantage.
Doing nothing is easy. Learning and making good decisions is the hard part -- the part that our Motley Fool Stock Advisor newsletter focuses on relentlessly. Learning and adapting from its past mistakes has made Stock Advisor hugely successful. If you'd like more information, click here for a free 30-day trial.