Five Golden Principles for Investors
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Following these five golden principles will keep you ahead of the stock markets:
1). Margin of Safety: The concept of margin of safety is the most important of Benjamin Graham’s investment principles. He argued that we should never overpay for our investments because our estimate of future cash flows of an investment could be wrong. As such, we require some protection, cushion or margin for our errors of estimation and judgment – so that the chances of getting satisfactory returns are brighter.
2). Understanding the Asset: Do your own research by spending your time on understanding the asset. For example, before investing in a stock or equity share of a company, learn about how the company earns its profits and revenues. Who are its competitors and how the company is tackling the competitive pressures? What is the quality of the management, its cash flow, profit and loss account and balance sheet? These fundamentals will keep you in good stead before you put a price on the stock.
3). Play Your Own Game: A fair knowledge of how financial markets operate is a necessary pre-requisite before you plunge into the investment world. Markets consist of millions of investors, speculators and traders. You have to play your own game to succeed against millions of others. Never follow the crowds. Mind you there will always be a few crooks ready to decamp with your money if you are not alert to their machinations.
4). Know Your Risk Appetite: Suppose you have invested $50,000 in a commodity hoping to get a return of 30 per cent in two years. Do you have the stomach to tolerate if the commodity’s price falls by 20 per cent or 25 per cent within a year, which is very common? If you require some cash urgently, are you prepared to sell this asset at a steep discount to your acquisition price? These questions will help you in understanding your own risk appetite.
5). Too Much Leverage is Dangerous: The collapse of hedge fund Long-Term Capital Management (LTCM) brought into focus the perils of over-leverage. LTCM, founded inter alia by two Nobel-laureates Robert Merton and Myron Scholes, had built up huge positions to the tune of $ 1,250 billions in financial derivatives market taking on leverage of about 35 times of its own funds. It collapsed in 1998 following Russia
Related: Understanding Asset Allocation 14Oct2012
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Disclaimer:
The author is an investment analyst, equity investor and freelance writer. This
write-up is for information purposes only and should not be taken as investment
advice. Investors are advised to consult their financial advisor before taking
any investment decisions. He blogs at:
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