16 Rules for Investing
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Heuristics - “involving or serving as an aid to learning, discovery, or problem-solving by experimental and especially trial-and-error methods”.
Put simply, heuristics are ‘rules of thumb’ we commonly use in order to make quick decisions from complex information. It simply isn’t possible for a humans to thrive in an environment without having ways to simplify complex decision making problems. Heuristics have been helpful in our evolution as a species, and are more common in some industries compared to others (such as finance).
In Finance, we use heuristics all the time.
Below, I have put together a list of 16 rules I commonly refer back to in order to help with focus. I would love to hear any additions you have.
Rule #1 - Look for skin in the game wherever possible
I’ve previously written an article focusing on the importance of ‘Skin in the game’. It explores its importance to both investors and the businesses they invest in.
Skin in the game is two-pronged - from the investors point of view it’s crucial to have skin in the game in order to have the motivation to learn and really ‘feel’ the emotions when investing in a company. There is no substitute.
From a businesses point of view, having a management team with strong ties to the company (be that a founder or good insider ownership) is a surefire route to success. Passion is hard to substitute.
I love this quote from Steve Jobs, outlining why having skin in the game is crucial.
“I think that without owning something over an extended period of time (several years), where one has a chance to take responsibility for one's recommendations. Where one has to see one's recommendations through all action stages and accumulate scar tissue for the mistakes, and pick oneself up off the ground, and dust oneself off… one learns a fraction of what one can.”
“When you're coming in and making recommendations and not owning the results, not owning the implementation… I think (you get) a fraction of the value and a fraction of the opportunity to learn and get better. You do get a broad cut at companies, but it's very thin. It's like a picture of banana – you might get a very accurate picture, but it's only two-dimensional. And without the experience of actually doing it, you never get three-dimensional. So you might have a lot of pictures on your walls. You can show off to your friends like ‘I've worked in bananas, I've worked in peaches, I've worked in grapes…’ etc. but you never really taste it.” - Steve Jobs
Rule #2 - Embrace being uncomfortable
"In investing, what is comfortable is rarely profitable." — Robert Arnott
Learning can often be uncomfortable at first. But with so much to learn, it’s necessary if you wish to succeed.
Rule #3 - Be weary of following the crowd
There is an innate safety built into following a crowd. It gives us a false sense of security - numbing us to the reality of a situation. We justify this to ourselves with the idea that the majority of people are usually right. And even if they’re wrong, at least I haven’t made a fool out of myself.
History is riddled with people following crowds - in wars, election cycles, ideologies, religion. The list goes on. Sometimes we don’t even need a leader, we are happy to take the path of least resistance.
Going against the grain is often met with criticism initially. Which makes these decisions initially hard, but ultimately profitable.
Independent thought is a valuable asset in this day and age.
Rule #4 - Avoid thinking in black and white
A key part of investing, and life, is the ability to think critically about the state of events happening around you at any given time. What makes this even harder is that most aspects of life fall into a grey area.
"Belonging is one of the things that makes life bearable, and it can be tough to look at a binary world and choose against both sides." - Andrew Solomon
Humans are complex animals - and, by extension, operate in a complex societal structure where there is almost never a simple yes/no or good/bad answer. This fact therefore requires us to ask questions almost constantly in order to rationalise the world around us.
In an attempt to combat this all too prevalent trap, my strategy is to investigate both sides of the argument with equal weight and (as much as I can) equal prejudice. Doing so often deepens my understanding on the topic as a whole and leads to better decision making.
Rule #5 - Remember, the retail investor always comes last
This rule isn’t meant to sound as pessimistic as it does. However it is a fact that you and I, as retail investors, are subject to the whims of the broader financial market. This market includes powerful and influential hedge funds and institutional investors with whom you are playing this game against.
One example of this is the IPO price retail investors receive compared to the price institutional investors receive. Late last year Airbnb IPOd to institutional investors at roughly $68 and shortly shot up to about $146 which was the only price available to retail investors.
Rule #6 - Tune out the noise
This article from Conor titled ‘Reflections on noise’ is a brilliant overview on the topic.
The modern world is overloaded with information - some valuable, but most is almost worthless. This especially applies to the financial sector.
“Owners of stocks, however, too often let the capricious and often irrational behavior of their fellow owners cause them to behave irrationally as well. Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits – and, worse yet, important to consider acting upon their comments.” – Warren Buffett
Twitter is probably the worst place to be if you want to avoid noise. Minute-by-minute updates and opinions are the norm.
Realistically, does it matter if company X missed quarterly earnings by 2% or company Y’s share price has spiked for no discernible reason? The answer, in the grand scheme of things, is most likely ‘no’.
As investors, we need to ask ourselves if a news item truly impacts our company’s long-term earnings power. The stock market is an unpredictable, dynamic force. We need to be very selective with the news we choose to listen to, much less act on. In my opinion, this is one of the most important pieces of investment advice.
Rule #7 - Buy, and then do nothing
“One of the best rules anybody can learn about investing is to do nothing, absolutely nothing, unless there is something to do.” - Jim Rogers
This rule somewhat comes down to your individual investing style. But for the most part, the strategy of buying for the long term without any intention to sell in the short term has proven to be a winning strategy.
Of course, if the underlying thesis for any of your investments changes you should absolutely re-visit the investment decision.
Doing nothing is arguably one of the hardest rules to follow, as it goes against our nature.
Rule #8 - Be weary of bubbles
It almost doesn’t need to be said, but bubbles can be one of the most destructive forces known to mankind. Therefore it’s always good to keep an eye out for signals indicating bubbles.
That being said, it’s almost impossible to predict any given bubble. Oftentimes, you will only notice the signs that you were in the bubble once it has burst.
“Booms start with some tie-in to reality, some reason which justifies the increase in asset values, and then -- and this is the critical feature of speculative mood -- the market loses touch with reality.” - John Kenneth Galbraith
Rule #9 - When buying or selling, make sure your emotions are in check.
“Individuals who can not master their emotions are ill-suited to profit from the investment process” - Benjamin Graham
The above quote, although a bit harsh, is based somewhat in truth. From personal experiences, my biggest investing mistakes have always happened when my emotions were either too high or too low.
One way to combat this is to constantly be checking your emotions when making important decisions. If possible, leave the decision and come back the next day/week and see if you feel the same way.
Rule #10 - Ignore short-term earnings. Focus on the core thesis.
Well, don’t completely ignore short-term earnings.
It is sometimes important to see if a company is on track to meet their targets. However getting bogged down in short-term thinking can be detrimental to long-term goals.
The most important point here is to make sure you ask yourself the question “does the core thesis still stand?”. As long as the answer to this question is yes, quarter-to-quarter earnings updates shouldn’t be weighted heavily in decisions to sell.
Rule #11 - Think two steps ahead. Identify trends and act accordingly.
One of my favourite parts about investing is the excuse it gives me to think into the future and imagine how developments made today could evolve over the coming years and who will benefit.
Remember, acting on these thoughts, although not easy, is crucial.
I made this mistake with Bitcoin back in 2014 when I knew enough to make an investment. It hurts, but has also taught me a great deal.
Rule #12 - Enjoy the 8th wonder of the world - compounding.
As much as you can, avoid withdrawing anything from your portfolio unless it’s absolutely necessary. Compounding can be the difference between a good portfolio return and a great one.
“Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it” - Albert Einstein
Rule #13 - Buy what you know.
It’s incredibly tempting to buy into a company/technology without fully understanding how it works.
Putting in the time to truly understand why you are investing in any given asset is key.
"There is nothing wrong with a 'know nothing' investor who realizes it. The problem is when you are a 'know nothing' investor but you think you know something." - Warren Buffett
Most will have spent their careers working in no more than a handful of industries, therefore we should have a good grasp on how these particular industries work. However, this leaves the majority of publicly traded companies to be outside of our circle of competence.
It’s not to say you should flat-out stay away from these areas, but apply caution and look for ‘experts’.
Rule #14 - If in doubt, zoom out.
Taking a step back from a situation or idea can give you some much needed context. As with most of life, context is key. We often get bogged down in the details or the short-term story whilst ignoring the long-term vision.
Rule #15 - There is never a perfect time to invest
“The Best Time To Invest Was Yesterday, The Second Best Time Is Today.”
This is one of the biggest mistakes I see new investors making, and within a year they almost always wish they had started investing as soon as possible.
Start today. Your future-self will thank you.
Rule #16 - Never compromise on quality
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” – Warren Buffett
Easier said than done, obviously.
There is no substitute for high-quality due-diligence when it comes to finding high-quality companies.
One place to find high-quality deep-dives on some of the worlds best companies is here, on the Innovestor Newsletter (shameless plug). Subscribe below in order to get these sent directly to your inbox.