Most financial articles out there focus on methods of generating profits and discuss upside potentials of companies. They talk about how you can make tons of money but never on how you can avoid losses. It is an inherent characteristic where we tend to avoid pain, loss and regret by focusing on the more positive aspects of life.
This attitude, however, won’t get you far in investing.
Many investors out there lose money, but we only hear about the stories of overnight superstar traders. The entire financial media is upwards biased so don’t take everything as the entire picture!
Investing is simple but not easy.
In this article, we will be sharing with you some of the many things that you should follow in order to not lose money when investing.
Invest in companies with little debt
Even if you are at the lowest point of the capital where everything seems in be in a mess, companies with little debt in the industry will have the best chance of survival. These companies are also the ones that will benefit the most when the industry inevitably recovers from the market low.
For instance, the oil & gas industry is currently entering a recovery phase. Many small companies which over-extended themselves went bust easily. While all these were happening, companies with solid balance sheets in the industry were restructuring and consolidating, positioning themselves well for the next inevitable recovery.
It is important to invest in companies with strong financials and clean balance sheets. As with the law of survival, only the fittest will survive.
This, however, doesn’t mean that you should invest in any good company at any price. Price is an important factor that determines your future returns too.
Are you praying more than thinking?
Very often, investors hope and wish that the holdings that have been underperforming will miraculously shoot up overnight. This hope that is founded on no fundamental premise is extremely dangerous for your portfolio. If you are subjected to such psychological influences easily, you will not make the right decisions when the time calls for it.
Allow us to illustrate two possible scenarios when an investor is contemplating about buying or selling.
First scenario: Selling after a rally
When your stock suddenly becomes a one-hit wonder overnight, there is a huge impulse for you to sell and take profit immediately. It is only after the act of realizing your profits that you have gained the sense of achievement and satisfaction from picking the ‘right’ stock. Or maybe perhaps you are fearful that the stock will revert to its original price.
Second scenario: Waiting after months or years of poor performance.
You have probably heard of a common saying about investing in the stock market: Just buy a few stocks and leave it there, visit it after a few years and you’ll be pleasantly surprised.
And they call this the buy and hold strategy and it lies on the premise that investing in equity will generate returns over the long run.
If you hold a mistake in hope that it will turnaround for you to sell, your portfolio will suffer because of your folly.
These are psychological pitfalls that many fall for and how can you prevent them?
Fortunately, the remedy for both scenarios is the same. If you have done your due diligence and have researched on its intrinsic value, you will have a good idea of what price you should be buying and selling at.
It doesn’t matter whether the stocks have rocketed or plunged, you sell when it is the time to sell.
The first step of insulating yourself from these psychological influences is to be aware of them. However, it will take hard work and discipline to cultivate the emotional intelligence necessary to perform in the financial market.
No one should have the audacity to claim that their investments will definitely pay off. Of course, we aren’t talking about the risk-free government bonds that will probably give you your 1-2% annualized return. We are talking about market-beating performances.
Even if you are 90% sure about your selection, it is never a good idea to invest close to 100% of your portfolio into that one stock. If you do that, there is a high chance that at least 1 out of 10 of your investment will wipe out your portfolio really quickly.
Always diversify based on the degree of uncertainty of your analysis and not to hedge against the performance of your other stocks.
This suggests that you shouldn’t be holding tens or hundreds of stocks in order to protect yourself from any risk of loss. The prevention of risk of loss is doing your homework, not by holding many subpar stocks.
The above three important points are just some of the many things a value investor should remember to minimize losses in the stock market. While these ideas are simple and straightforward, you’d be surprised at how most individuals fail at it.
We are more than happy to be sharing with you the key insights and mistakes we have made in our value investing journey so that you won’t make the same ones such as the following 2 articles we have shortlisted!