Ten basic rules for lifelong success on the stock market
February 20, 2019
11 minutes to read
It's all about the miracle of compound interest. If a prudent investor is able to obtain a return of 12% annually then, after 40 years, they will have made 930,000 euros for every 10,000 euros invested. And the good news is that anyone can actually do it.
And here's more good news: it is not really about sophisticated models or large amounts or expensive advisers. Instead, it's about simplicity, dedication, perseverance, trust and other factors available to everyone. All you need can be found in the following ten principles.
"1. Replace the revolving door of the stock market with a door without an inside handle."
It's a pity that the entrance to the stock exchange is a room-wide revolving door, and not a sturdy door without a handle on the inside. How readily and often do investors use that revolving door and how often do they complain about it afterwards? That expensive habit of always going in and out of the market is the main reason why there is such a profound gap between the average long-term return of most of the stock market indices (around 7% a year) and the average return for investors (2-3%). They leave in an attempt to avoid the bad days and because of that they miss the good days above all.
As a result, waiting for a crash becomes more expensive than the crash itself. So many Belgian savers have been too cautious to buy shares in the past. That's a pity, as their 268 billion euros in savings accounts have yielded virtually nothing in the past ten years. In that time, my portfolio has achieved a return of 293%. If the stock market were to crash tomorrow, it would have to crash by 75% to push me back to my February 2009 position. In other words: Ten years spent avoiding the stock market for fear of a crash costs the saver as much as an exceptionally devastating crash of 75%.
There is an exception to this outer door rule. One type of investor often has to go back inside: the beginner. Do not buy your first shares all at once; instead, for example, buy one per month so to avoid the risk of buying everything at the top of a cycle.
"2. Clear the weeds and let the flowers bloom."
The following wise words might have been hammered into you already: ‘cut your losses, let your profits run.’ It is one of the best pieces of advice in the world, but also the one that is disregarded more than any other. That's why it is worth repeating again and again. The tendency to sell well-performing stock far too quickly and keep poorly performing shares for far too long is a notable (not to mention huge) mistake.
Everyone understands the flower garden metaphor: you don't pick the beautiful flowers, and you don't spray the weeds in the hope that they'll turn into beautiful flowers. However, this is something we do on the stock market. Why? Because we don't like admitting our mistakes. We bought weeds believing them to be flowers. Instead of saying: 'Bad choice, get rid of them', we reason: ‘maybe if I wait long enough, that miserable load of weeds will turn into beautiful flowers.’ And what do we so often do with the beautiful flowers? Sell! And often enough, we do it to buy weeds in exchange.
That is twice as sad, as the stock market offers us a unique – and potentially extremely lucrative – advantage: the law of asymmetric returns. If you invest 1,000 euros in a share, then you can lose at most 1,000 euros. You can also gain much more than 1,000 euros – in the case of some shares, it can be twenty times as much. You could gain so much more than you lose. Is that not the ultimate argument for keeping on investing in well-performing stocks?
"3. Focus on the market, not on the news."
Headlines - Summer 2018: strong American economy, record company earnings, large technology shares popular. Reaction from the markets: everything up. Headlines - fourth quarter of 2018: trade war, American interest rate increases, Chinese growth slowing down, Brexit, rebellious Italians and a Donald Trump who turfs out all the normal people from the White House. Result: market crashes. Headlines - January 2019: thaw in American-Chinese relations and a break in US interest rate hikes. Reaction: everything up.
But what has fundamentally changed since last summer? The answer is nothing. You could have saved yourself all that manic-depressive hassle by simply focusing on the news about the stocks in your portfolio.
What you need to realise is that 95% of all news is useless as an indicator of which way the stock market is heading. Even stock market commentaries are riddled with causalities and make connections where there are none. For example: the fact that more barbecues take place in Flanders on days when there are traffic jams on the roads to the coast does not mean that a traffic jam on the coast causes more barbecues to be held. Nor does it mean that a barbecue causes more traffic jams on the roads heading to the coast.
4. A bargain can be a bargain.
Never buy shares because their price has reached the lowest level in years. It's true that Nyrstar shares are at 0.35 euros today and were at 35 euros seven years ago. But that in itself doesn't make the share any more attractive in 2019. Unlike a coffee mug or a set of towels, it is no longer the same product. The company is completely different, financially speaking, from what it was in 2012; it's not the same market and the outlook has changed drastically.
In other words; do not compare the present with a past situation. Instead, only compare it with what you believe to be fair value today.
Moreover, a drop in price can persist for a long time. This is often accompanied by a long period during which the company is also less operational/earnings are lower. When talking about the first disappointing quarterly results of a company, Warren Buffett once said: ‘There's never just one cockroach in the kitchen.’ Setbacks often occur in series. Windfalls do too.
"5. Crystal balls exist, but they don't help you to see into the future."
‘The prices of my shares have already risen nicely. Wouldn't it be best to sell everything now, wait for the crash and then get back in again when things are cheap?’ If you still think that's the thing to do – despite my first rule about the revolving door – you haven't yet fully understood the issue. Just to be clear: although the next crash is definitely coming, nobody knows when it will happen. Don't take it into account.
‘The prices of my shares have already been falling for so long. It's best that I sell everything, because Armageddon is nigh…’ We often hear such reasoning, even though it is the perfect mirror image of the above. This time, the investor does not expect the trend to change because it has been going on for so long, but rather for it to continue precisely because it has already being going on for so long. Getting it right is a question of luck. The majority of people make the same mistake: for them, the stock market is like a car but with the windscreen replaced by a mirror. They think they can go forward safely by staring into the rear-view mirror.
"6. The more cautious the investor, the higher their return."
According to this widely taught financial theory: ‘If you want to win a lot, you have to take extra risks.’ This may be true for cyclists who want to win the Tour de France, causing them to shoot down a mountain with a total disregard for death.
But the reverse applies to investors: a person committed to the long term avoids the big risks and adheres to a simple and effective system at all times. This stops them from breaking their neck on the Alpine slopes. They stay in the race, right up to the finish line, and ultimately achieve a much higher return than the kamikaze pilot who has had to drop out en route.
It is crucial for an investor to know what they are doing, especially in crisis situations. A person who makes mistakes is one who has lost sight of this – they spend their time looking at gory headlines for guidance, take their eye off the ball and become queasy from following the twists and turns of the delusion of the day. As a result, they will sell in a moment of blind panic and turn their back on the stock market. Alternatively, they will take too many risks, playing everything or nothing as quickly as possible to make up for the loss incurred.
Thanks to my system and its buying and selling limits, I don't have to do that. I just do what that system tells me. And it is easy enough.
"7. Take your time as an ally rather than an adversary."
An investor can effortlessly stay on the right course toward achieving good returns provided that time does not play to their disadvantage.
Any investment where time is against you is to be avoided: buying options, for example, or turbos or other derivative products that are not for hedging a risk. Shorts are another example – selling securities that are not yours and hoping to buy them later at a cheaper rate. And above all: borrowing money to invest it. The loan has always to be paid back after a certain time.
All these activities have one thing in common: you must hope that the price moves sufficiently in the right direction within a limited time frame. You are therefore dependant on luck. We're happy to leave that type of activity to speculators. Investing in stocks is fascinating enough without turbos, shorts, butterflies and other exotic things.
"8. Buy a share as if you were buying the entire business."
Most investors are usually more concerned about the question of selling than of buying. It should be the other way round. Selling must be a no-brainer. Sell if a limit is exceeded in your investor model or, in a rare case, that the company no longer meets your initial requirements. Otherwise: do not sell.
Buying is more difficult. Which shares shall I buy? There is no golden formula for this. It is a mix of calculations and assumptions, without any guarantee for success. I also have an additional requirement: I must have wanted the share for at least three months. Have I discovered something desirable? If the answer is yes, it gets a place in my purchase waiting room, where it has to stay for three months. I do not make things easy for it. Like a lawyer who wants to anticipate all the arguments of the other party, I try to find reasons for not buying the share. With that in mind in particular, I occasionally take a peek in the waiting room: that potential partner has to continue to look desirable the entire time.
In other words, buying has to be something special, almost like a marriage. At the time of purchase, imagine that you are taking over the entire business. You understand that you can't buy a complete business every day – not even every ten years. You are not AB InBev. It is a unique transaction for you. Are you going to do it or not? This thought experiment forces you to carefully consider the pros and cons, weigh up the options and, above all, take your time before making a decision. After all, this purchase will change your life.
Of course, it is not so serious on the stock market. Should you no longer want the shares you bought, you can dispose of them with a click of the mouse. But by convincing yourself that you are actually buying the entire business, you will hopefully avoid doing what so many others do: buying shares for thousands of euros as if they were quickly grabbing a bar of chocolate at the supermarket checkout without really knowing anything about the brand or taste.
"9. Don't be a lemming that follows other lemmings."
‘Anyone who follows the herd ends up in the wringer’, is a delightfully phrased stock market saying. Every now and then a clear image helps – do you see yourself running along at the back of a stampede? Something that is regularly heard on the stock market: I'm buying because they are. But who says that other person is right? Leo Tolstoy, the man behind Anna Karenina, said: ‘Wrong does not cease to be wrong because the majority share in it.’
This is certainly the case on the stock market. This world is extremely conformist. Anyone who wants to join in will automatically start to behave like everyone else. That quickly muddles any clear thinking. In particular, it gives the dangerous impression that the group's conviction is right by definition – after all, it would be difficult for 100,000 lemmings to all be wrong at the same time, wouldn't it? Actually, not really. It is the many who are usually wrong, not the few. Money tends to flow from the many to a few. In the long run, the majority get hit, so make sure you're in the minority.
You can, of course, listen to tips, but don't just take them at face value. Study the arguments and ensure you are 100% convinced before you make the transaction. After all, it's your transaction. Furthermore, a tip is based on the information of the moment, and the arguments may already cease to apply the next day.
There is one more important reason to not blindly respond to ‘hot tips’. Investors who shift responsibility for their actions onto others are too weak, mentally speaking, to be successful over the long term. They outsource the thinking and therefore do not often understand what is happening – which makes them insecure. They are too emotional: they hope, and if things turn out badly, their hope will turn into anger. Good investors leave emotions such as hope and anger at the door. Do that too.
"10. Invest especially and above all in yourself."
Buffett often says: ‘You are your most important asset. That's why you should invest as much as possible in yourself.’ In your personal development, to be exact. Work on your talents, read, listen and learn. The wise Charlie Munger once said you should try to go to bed smarter than when you woke up. The return on investment can be phenomenal. And here's an extra benefit: nobody can take it away from you; nobody can take away this kind of gain from you.
Also invest in your well-being. Good investors are happy people, and vice versa. They are optimists who believe in a better future. A pessimist can't get a 12% annual return over 20 years – it's not possible. They see danger everywhere, sell too fast, and are often too cynical to see what's beautiful in the many listed companies that our country is abundant in.
Pierre Huylenbroeck is the author of Onsterfelijk Beursadvies and Iedereen Belegger. He publishes Mister Market Magazine, a biweekly digital journal for curious investors. Please download a free trial issue.