A novice investor is faced with many questions: what instruments to invest in, how to choose the right moment to buy assets, how to create a portfolio. We’ve prepared 5 tips from legendary investors who know exactly where to start.
Determine your risk appetite
“You have to look in the mirror and ask yourself, ‘What will I do if the stock market falls 10% over the next year? Will I sell everything?”said one of the most successful investors in the world, Peter Lynch.
Each investor, before choosing investment instruments, needs to determine the risk appetite. For example, if you are not ready for the fact that your capital will decrease in a short period, then it is better not to invest in stocks, but to choose bonds. You need to be prepared for the fact that the value of shares in the short term may decline.
If you invest in stocks, be patient. “The Oracle of Omaha” Warren Buffett is the most famous proponent of the buy and hold strategy. He said that the best way to make money on investments is to buy a share for 10 years and forget about it.
Invest in what you understand
This principle will help you not to give in to emotions: if you understand the business of a company and are confident in it, then it will be easier for you to resist selling its shares at the first fall. Buffett and Lynch can be called a supporter of this approach. Lynch said that the average investor does not need to spend a lot of time looking for stocks to invest. According to him, it is enough to invest in 5-10 companies, in the business of which you can independently figure out.
Buffett invites the investor to test himself: if you can explain in 10 minutes what factors affect the income of a company and its industry, then you can invest in such a company.
Choose the right time to start investing
Some prominent investors often write that an investor needs to do timing, that is, look for the perfect moment to buy assets. You can use the indicator popularized by Nobel laureate Robert Schiller – the price-to-earnings (P / E) ratio.
P / E is the ratio of the capitalization of all companies to their annual profit. The lower the ratio, the more investors underestimate the market (this ratio can also be used to value companies). The larger it is, the more “overheated” the market is.
Using the American market as an example, Schiller calculated that investors who entered the market at a P / E ratio of 25 or higher are guaranteed to receive close to zero or even negative returns in the short term. American investors enter the market when the P / E is not higher than 10, you can earn up to 12% per annum on average over the next 20 years. Investing in stocks with 10x price to sales will likely result in losses just as what happened to Sun Microsystems. Those who purchased Sun Microsystems stock which was then trading 10x price to sales lost 95% of their money.
Choose “Blue Chips”
If you decide to invest in stocks, then you should choose only the most reliable companies. It’s great if they also show consistent profit growth. Benjamin Graham, the legendary investor, father of value investing and teacher of Warren Buffett, wrote about this in his book The Intelligent Investor. Graham believed that profits over the past 10 years should grow by at least 30% (this is about 2.5% per year), while not in any of the last 5 years should they fall.
Diversify your portfolio to include more than just stocks and bonds
Diversification is one of the most important principles of a successful investor. By investing in different instruments (for example, stocks and bonds), you reduce risks. However, a novice investor may not know how to properly assemble a diversified portfolio.
It should be more than just stocks and bonds, says Ray Dalio, founder of Bridgewater, the world’s largest hedge fund. The optimal portfolio, according to Dalio, might look like this:
- 30% of investments – in shares of large companies,
- 15% – gold and other raw materials,
- 40% – long-term government bonds,
- 15% – medium-term bonds.
Such a portfolio will demonstrate profitability even during economic downturns and market crises, Dalio said. To reduce the risks, investing in shares should also be divided between different industries: for example, you should not invest only in shares of oil and gas companies. The oil price may go down, followed by quotes.