When investing, what is the most important principle to keep in mind? Is it to buy "safe" stocks? Think for the long term? Or, is it something else entirely?
Now, while there is no one rule that's undoubtedly the "most important", but there are definitely a few that are very important to use in your own investment strategy. With that in mind, we asked three of our experts to explain their most important investing rules, and here is what they had to say.
The most important rule of investing is to learn, learn, learn... and keep learning. Beginning investors need to learn how the stock market works, and lots of key concepts, such as that a share of stock gives you a (small) ownership stake in a real business, a stock's price alone isn't too meaningful, a stock split isn't that exciting because it doesn't change your investment's value much, don't buy stock in companies you don't understand, expect occasional market corrections, it's important to diversify so that you don't keep too many eggs in one basket, and you need to keep up with your holdings regularly so that you notice if any company grows less promising over time.
As you go through your investing life, you can keep learning in several ways. For starters, you should learn from your mistakes. Common mistakes made by beginning investors (and even some seasoned ones) include bailing when a stock or the market drops, trading too frequently and not being patient, falling for penny-stock come-ons, and taking on too much risk by buying stocks on margin.
You can also learn from the masters, as they can save you from making some mistakes and can improve your investment approach. Even Warren Buffett credits his partner Charlie Munger with getting him to see that it's better to buy a great company at a fair price than a fair company at a great price. He was making plenty of money with his earlier approach, but by continuing to keep an open mind and learning from others (as well as from the many annual reports and other things he read), he improved his results. Munger himself has said, "The game of life is the game of everlasting learning. At least it is if you want to win."
I'm a big fan of Seth Klarman, one of the world's best hedge fund managers. His book on investing, Margin of Safety, is full of insights, but one of the best may be the most simple: Focus on what you can know.
All too often investors get an idea, and then try to find stocks that fit it. A timely example might be rising interest rates. If rates go up, a whole slew of businesses will make more money. Some will make less money. But making an investment return on that idea is very hard to do. You have to know where rates will go, when, and why what is true today won't change in the future.
It's almost impossible to do.
Investors would be best left to focus on the basics, and stick to what they can possibly know. It's knowable that Warren Buffett's company, Berkshire Hathaway (NYSE:BRK-A)(NYSE:BRK-B), gets special access to investments. That gives him an advantage. It's knowable that Costco (NASDAQ:COST) sells more product per square foot and turns its inventory over faster than virtually all of its competitors. That gives it an advantage. It's knowable that RadioShack's (OTC:RSHCQ) competitors sell the same stuff at lower prices. That puts it at a massive disadvantage.
The above concepts are simple ideas that have underlied investment profits to the tune of billions of dollars. Simple ideas won't earn you a Nobel Prize, but they can earn you fantastic results in the stock market.
The most important investing rule was put forward by the founder of value investing, Ben Graham, in Chapter 20 of The Intelligent Investor: "Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY."
In investing, a margin of safety is formed when one buys an investment at less than its intrinsic value, or earning power, while using conservative assumptions. While investors try their hardest to assess how a business will do going forward, the idea of a margin of safety is that you want to buy a business at a price that is low enough that your assessment could be completely wrong and you wouldn't lose much.
As Graham explains: "[T]he function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future."
One of the biggest proponents of a margin of safety is Warren Buffett, who learned from Graham. Buffett has expanded upon the idea about margin of safety -- he is convinced that it can also be found in the quality of a business. An investor certainly can pay too high a price for a great business. But buying a business that can reinvest in itself over the long term can be a far better decision than simply buying an undervalued asset that appears to be a bargain.