We are nearing the end of our value investing course – Value Investing for Smart People. At this juncture, let’s spend some time on understanding the five habits that you as an investor can practice to become better at investing in the stock markets.
Let’s start right here.
Habit #1: Set a goal, and work towards it
You would vouch for the fact that the core reason you are an investor is because you want to create wealth for yourself and your family. And you would also agree that there are some reasons you want to create this wealth.
The reason might be to:
- Create a nest egg for a post retirement life.
- Plan for the education and marriage of children.
- Accumulate money to go on a world tour.
- Create wealth to meet all these wants, wishes, and obligations.
So, it is important that you have some financial goals in mind for which you are working (investing) to create that kind of a resource pool. But then, you might be one of those majority investors who do not have any goal for which they invest. Ask them why they invest in stocks, and the plain answer – “To make money!”
Of course the idea is to make money. But the bigger idea here is to have a future goal for which to make money by investing in stocks. So, if you haven’t yet set yourself such a goal, do it now.
But just remember one thing – the goals you set are not static and are very much subject to change. So, be realistic and flexible. Revisit your goals whenever there has been a major change in your life, such as marriage, child birth, or the purchase of a home.
Habit #2: Know basic accounting
Not complex accounting that companies use to manipulate their earnings! But you need to understand the basic accounting concepts before you even become an investor. After all, accounting is the language of business. And just like you learned the basic grammar in school to be able to speak and write now, you need to understand basic accounting to identify good companies from the bad ones based on their past financial performance.
Sincerely, if you cannot tell the difference between something like a current asset and a fixed asset, you have no right to invest in the stock markets.
Habit #3: Read…read…read
That’s the best habit that to can have as an investor. Successful investors will tell you that if you just read a company’s annual report, you will be better read than 90% of all investors. And if you read the footnotes (explanations) after the financial statements in an annual report, you’ll be better than 99% of all investors.
Warren Buffett’s business partner Charlie Munger once said, “In my whole life, I have known no wise people over a broad subject matter area who didn’t read all the time – none, zero.”
Buffett and Munger are both well-known for the incredible amount of reading they do. And you can follow their footsteps by starting with reading a lot.
Read books on value investing. Read books on human behaviour. Read books on the financial history of the world. You never know when you’ll find a brilliant idea to add to your repertoire.
Read the daily newspapers, read the annual reports, read the biographies of successful businessmen.
Knowledge is power, and there is no shortcut to success. Not even in investing!
Habit #4: Mind your behaviour
As you must have read in lesson 13, minding your own behaviour plays a critical role in your acts as an investor. We humans are not hard-wired to be rational beings despite the fact that we clam this honour. The truth is that we are rationalising beings. We make emotional decisions and then try to rationalise the same with logic.
Sensible investing however requires that we notice where our emotions are guiding us to, and then take preventive measures to fall in emotional traps. Traps like:
- Being overconfident – We know all the right answers!
- Wishful thinking – Hearing from others what we believe to be true.
- Availability bias – Believing the news that’s readily available.
- Framing – Going by how words are framed and not the rationale behind the same.
- Following the herd – My truth, your truth, ‘the’ truth!
Habit #5: Understand risk
This is the hardest habit to form, simply because most of us investors never count risk as part of the equation. And those who do, have a fuzzy idea of what ‘risk’ really means.
In general terms, investing risk refers to the uncertainty of the occurrence of a certain event that can affect future returns. But ask Buffett, and he would go a step further. Buffett defines risk as ‘permanent loss of capital’.
As per this definition, risk is to lose whatever you’ve invested and not have any chance to get it back. Short term fluctuations in the stock prices, therefore, don’t equate with ‘risk’, as is generally considered in the investing circles.
So the good idea for you to become a smart investor is to understand what risks you are taking while investing in stocks.
Before buying a stock, try to answer this question – “Can this stock cause a permanent loss of capital to me?”
If your answer is ‘yes’, or even ‘maybe’, you better stay away from that stock. Buying it despite knowing that it would involve risk-taking would be foolish.
Of course we can never eliminate risks from stock market investing, but we surely can minimise the chances of the same.
P.S.: Got here via a link from a friend, or a forwarded email? This is the fifteenth lesson of the 20-lesson free email course on the essential pillars of becoming a successful investor, Safal Niveshak-style. We talk about simple investing strategies that will work for you, and make you a smarter and successful investor.
Learn more about the course or simply sign up here.