Momentum, Macro, pattern recognition
Contributor Since 2012
The second time I was published by McGraw-Hill I made sure to provide them with a picture of myself, because after seeing my first book, my 9-year old niece said, "How do I even know this is you? There's no picture on the back!"
Being skeptical can be a healthy trait for all of us when it comes to long-term investing.
I was excited to hear from that same niece that she and her little brother are drawing up an investment plan, and asked for my input.
Here are seven, common sense rules I worked out to get the kids started.
Rule 1. Make sure each investment you make is supported by a simple concept that is also a truism. Ex: People need to eat; therefore corn has good potential as an investment. Or, currencies are cyclical, so it's a good idea to be long a currency when it's in an up cycle, and avoid exposure to it in a down cycle. State the reason why you are considering the investment and then ask: "Do I absolutely know this to be true?"
Rule 2. Never make long-term bets against human progress, yet focus on people's needs more than wants. "Pessimists don't make money on Wall Street", is a wise old saying. Looking back over the last 50 years it is obvious we have made great strides in modernization. This is a trend that is not likely to end in your lifetime. Yet there will be many fads and flops along the way. And a great yardstick to differentiate the next great advance from the fads and flops is the question "is it a long-term need or a short-term want?" A great example of this is the cell phone. Plenty of old timers may have said a cell phone was a want. But to a parent, who is lending their car to their son or daughter for a road-trip, that cell phone is a potential lifeline - a need.
Rule 3. Determine how much of your income you want to invest each payday, or each month, and put that amount into your investment or stock account religiously. Once you have decided which markets or stocks to invest in you will be putting a fixed amount of money into that instrument each month (this age old strategy is known as "dollar cost averaging"). The advantage of dollar cost averaging is you will be automatically accumulating more shares at lower prices and fewer shares at higher prices, and eliminating the temptation to try to "time the market". Never confuse investing with trading.
The percentage of your account which you allocate to any one investment will be up to you but a good rule of thumb is no more than 20% of the entire account should be put in any one investment.
Rule 4. Make sure each investment you consider has a heavily traded stock, or ETF accompanying it. Many brokers today offer commission free ETF's. (An EFT is an Exchange Traded Fund which mimics a commodity, currency, or index) This is great for smaller investors who want to invest / dollar cost average smaller amounts of money on a monthly or bi-monthly basis. Investing is like any other business where the lower the expenses the higher the profit. Commissions are definitely an expense you want to avoid when you can.
Rule 5. Look to profit from lack of change, rather than from coming change. This rule is straight out of Warren Buffett's playbook. No one knows what the futures holds, but it is more likely that something that is working well now will continue to work in the future. Ex: Everyone has to pay their gas bill if they want the house to be heated in the winter. It is very likely they will continue to pay that utility bill. Therefore I will buy on a dollar cost average basis Exelon -EXC - as long as it is in the lower 1/2 of its 15-year price range, because it is the largest energy provider in the U.S. See Figure 1.
Rule 6. A picture is worth 1,000 words. A price chart is factual, and non-emotional, and the most accurate reflection of the actual events that moved a market (investment). Ex: Figure 2 shows the history of corn prices in the U.S. over the last 35 years. We don't need to look up weather records to see what years there were drought conditions - and supply was limited -- they are marked on the chart by price spikes - rallies. We just need access to the ETF CORN. Trust the history of price cycles and charts more than what financial journalists are writing about today. Market's will always bottom on bad news and top on good news which means you need to go against the consensus which means doing the opposite of what financial headlines are screaming. Likewise a price chart will help you to not fall too deeply in love with an investment. The only reason you purchase an investment is to eventually convert it back to cash. Common sense can never be underrated when it comes to investing.
The single most effective tactic for investors is the simple observation that a market is creating higher lows and higher highs - an uptrend (a reflection of bullish underlying conditions) - or lower highs and lower lows - a downtrend (a reflection of bearish conditions).
Rule 7: Have a time horizon - investment expectation -- of as long as 10 years per investment. Bull and Bear moves take time to unfold, and investors need to be more patient than nature herself; both in entering investments and then allowing profits to run. The corn chart in Figure 2 is a great example of this. Buying corn at the beginning of 2005 at $3.00 was a great idea, yet it dropped down to $2.00 and stayed there for much of that year, which would have created a 50% loss for buyers at $3.00! For a patient investor who continued to purchase it every month it was a spectacular investment that yielded nearly 300% by 2012.
These seven rules will put the kids years ahead in their investment plans. But the most important thing to remember is still the golden rule of getting things done: "keep it simple". If something does not make sense right away, or there is any doubt, then don't do it. Opportunities in the markets are like planes, if you miss one, there will be another one to get on board tomorrow.
Jay Norris is the author of several books on trading and an instructor at Trading University