In our preceding post we discussed how stock markets work (link to Article 17 Introducing New Investor to Stock Market); in this post I am going to highlight a theory and some principals that I strongly recommend every new and semi experienced trader and investor to read before he decides what does he want to do to become rich, build a net worth; and more importantly evaluate the approach he wants to take to get there.
Whether or not you agree with what’s written over here or choose to apply it in your life comes later; first and foremost read the post which has taken me more effort than most posts generally do, and therefore I am pinning extra hopes on the benefits in generates; I hope my effort makes sense for my valued readers; the beginners especially.
The first mandatory rule for becoming rich is EARNING. This rule applies irrespective of class, caste, colour, country and more. The first golden lesson therefore is to identify a source, vocation, job or profession that you would like to pursue to earn your basic, stable income that will help to pay your regular bills. Once that aspect gets streamlined and stabilised; its time to move on to the next – the second golden rule; i.e. of adding additional streams of income to your existing pay packet; which can be achieved in several ways.
Lets say your basic source of income is generated via your job as an accountant; chef; surgeon; teacher etc. Next, you can utilize your after office hours in learning a new skill or earning a new degree which will help you open another steam of income. Like starting carpet, car cleaning, ticketing, or lawn moving services; tutoring; and so on. You can even become consultant in your spare time in the field you specialize in. This additional source of income will tend to have a great impact on your self confidence. It will help you to see through the illusion of job security and take better control of your destiny.
This extra income (however little that might be to begin with), when added over a period of time will become quite an amount. When this lump sum earned from the second or subsequent steam of income year after years gets sensibly invested in stock market; in 20 years time it can make your net worth many more times higher than what it would have been (if at all anything) otherwise. This is the third golden rule of becoming rich. We shall discuss this rule at length to understand the intricacies clearly.
To build a net worth takes time. Like the famous investor himself once said that it takes nine months for a woman to deliver a healthy baby; and the same cannot be achieved or replaced by arranging nine women willing to become pregnant for one month each. What takes time, takes time. Buying and holding stocks are no exceptions to this rule. So focus on building a complete portfolio.
Second is to always follow the Berkshire Hathaway business module which says one should not only focus on diversifying the assets alone but also his/her income streams. Creating multiples steams of income does not only help to build you a healthy net worth for yourself; but it also helps you survive the financial crises. Third Golden rule is to invest in what you understand in and can explain it to your family. If something sounds too intimidating or complex, avoid investing in such stocks, because however good they might be, if you don’t understand the dynamics that make it work, its of little use.
Identify companies that pay high returns on stocks, boast of long lasting competitive advantages; active management that runs the company as if it were their own and clear to read and understand financial statements like balance sheets. It takes a wise investor to know that it is better to invest in a mediocre company which has a team of reasonably realistic, sensible and hardworking mangers than investing in companies with brilliant concepts, future plans, capital, and strategies lead by poor & over- rated managerial strength. If you can identify such companies to invest your money in, you are hardly gambling.
As a trader or investor, never underestimate or ignore the margin of safety aspect. Margin of safety is the difference in value between what a trader pays for (whether it is stock, bond, mutual fund or whatever) against asset of financial instrument and its intrinsic value. Margin or Safety does not only help traders to earn good returns on investment but also protects them against flawed judgements; and unforeseen business related problems.
If you are someone who has time at hand to study and analyse the market, go for small stocks because at any given point of time there are hundreds and thousands of profitable opportunities cropping up; however if you are one of those who does not have the time then it is advised that you reach for the index fund of the S & P 500.
As investors be financial as independent as you can. It means your existence and daily expenses should not depend on one stream of income alone at any given point of time. Keep liabilities as low as possible, zero if possible; reinvest profits with wisdom; keep ample liquid cash in hand or bank. Another skill that is must for a trader to possess is ability to communicate – and when we speak of communication as a skill it does not just mean talent with words, talent to write, and read; it also means developing and fine-tuning the skill to listen and understand. That is what makes the theory of communication complete. If you don’t have the skill, work on it because if you don’t understand the meaning of what you hear or read or can’t explain to your advisor and broker what you want, then the whole effort goes for a toss!
Even if you consider yourself an average investor doing national level trading so far; international market is what your next destination should be which you should explore and find a foot-hold in – this is the last golden rule of this post. Learn to invest globally. Whether it is through ETF, global trading accounts or through international broker accounts, as long as they offer you the freedom to hedge or convert your currency into another do take your chances with international stock exchange transactions and explore the avenue.