The fundamentals of investing
02-11-07: Sometime we find it useful to remind ourselves of the fundamentals of investing. It is easy to get caught up in the moment and make irrational decision. To keep ourselves from making decisions on the fly, we must remind ourselves that investing is a process that should be driven by well-developed plans with specific goals in mind. Goals are important as it will help us address the most common question we face on a daily basis. Should I keep this stock or sell it? Should I take profit? Should I accept the lost and move on? We all face these questions as investors. This article will attempt to provide some guidelines to help with these questions.
Establish your goal: When buying stocks, bonds or mutual funds, it is important to determine the goals of your investment. The typical goals are accumulating for retirement, enhancing current income, saving for major purchase and tax shelter from income taxes. Your investment behavior should be reflective of these goals.
Whenever we decide to buy stock of any company, our goal is to achieve an above average return in comparison to the S&P 500. We feel if we can achieve return close to the S&P 500, it is a good investment. Anything above the S&P 500 would be viewed as an above average return and would warrant profit taking along the way. As a result of this predetermined goal, we are able to make decision without questioning ourselves.
In contrast, we also set the amount in which we can stomach to loose. Personally, our stop loss is 20 percent from our initial investment. Depending on your risk tolerance level, this will vary. In our view, if we are down 20 percent, it could go much lower and it is time to salvage the investment and move on to something else. While it is extremely difficult to accept defeat, it has saved us on more than several occasions. In our view, having a protection or risk reduction strategies is more important that knowing when to exit after a gain. Know your limits.
Minimize stock turnover: To reduce stock turnover, it is important to have a game plan when it comes to the selection process. Our strategy is to concentrate our funds in undervalued stocks, undervalued sectors or industries. We have found this strategy to work quite well. While determining if certain stock is undervalued requires tremendous work, it is worth the time. Staying away from stocks that are “hot” is sometime hard to do, but we have found attempting to catch a “hot stock” will only end up in failure. The market is too efficient.
Lastly, do you know yourself? Knowing who you are as an investor will determine your behavior in respect to your stock selection process. What is your risk tolerance? How much can you afford to lose? What are the tax implications? What is your investment goal? This sounds easy enough, but most people find it difficult to answer these fundamental questions.
