Here is my basic strategy
- not to be greedy (and understand your risk level)
- time is one's best friend, and consistancy is how to achieve it
- invest in what I know, not what I am told.
- contradictory to normal belief, diversify does not reduce risk nor give good return.
and let me explain one by one.
1) not to be greedy (and understand your risk level)
Everybody knows that you will make money if you can buy low and sell high. But often times people hold on to a stock for too long, waiting for it to rise another 1%, and only to see it crashed 10%. The key to have consistant good return is not to be greedy. As we mentioned in previous section, you need to seriously think about selling it when you hit 10% gain. Unless you studies this stock really well and you can confident on its contine growth (as well as the positive condition of overall market), you can wait to 20%. At that point, you should definitely sell it. You will miss some good stocks that will eventually hit 200% return, but you will avoid a lot of losses.
You can give yourself a quotation, let's say 10% of your stock profolio, that you are willing to loss all. For this quotation, you are willing to hold on to more that 20% gain (and you will not cry if you loss all of it). That's the risk pool that you will mentally compartmetize your risky investment vs. your normal 10 - 20% selling point. You can not fully beat your urge for greed, but you can use your 10% risk pool to control your greed.
2) time is one's best friend, and consistancy is how to achieve it
As we talked before about 7-10 rule, you can make 24 = 1600% return of investment if you have 7% return per year for 40 years. Nothing beats 1600% ROI. So, the basic message is to invest early and to invest young. Unfortunately, most of us do not have much money when we are young, and we do not have much knowledge about investment. Fortunately, since you are reading this, you will gain enough knowledge. You just have to work hard, and reduce the amount of money you used for fun when you are young. It will pay huge divident down the road. There will be enough time for you to have fun later, but there will not be enough time for you to grow your investment.
Just remember this, the $5 beer you are having at the ball park is actually $80 when you are 60 years old (or $320 when you are 80 years old). Are you really going to spend $320 on a single beer ?
3) invest in what I know, not what I am told.
Everybody wants to pick the winning stock. Let me tell you this :
-- there is no way to pick the best winning stock. FORGET ABOUT IT. You will never know what's the next Apple or Google stock.
-- but you can always pick the stock that meet your 7% annual growth target (in fact, I am consistantly doing 10 - 20% per year).
The best strategy is to pick the company you know.
For example, if you are in computer chip business, you probably know who your competitors are, which company supplies materials and components to your industry, and which company your industry sell products to. This is the field you are very familiar with, and you should pick the strong ones from here (assuming, as said in Chapter 3, you are paying attention to your job and you are learning everyday).
Another example is to choose from the companies that impacts your daily life. For example, how often do you eat at McDonald ? Every time you go, is there more customers and less customers ? Are they plan to introduce new menu items that you think people will really like ? When you go to vacations in developing country, do you see more McDonald building up everywhere ? This gives you hint on whether to invest McDonald stock. Or, if you or your friend just had a baby, which daiper did you choose ? Why did you choose this band vs another ? Does most people do the same ? This gives you idea of which company to invest and which not.
The stock investment opportunity is everywhere. The question is whether you are looking at those things as investment opportunity or not. It takes practice to train your mind to think this way. Let's try this : everyday, from your daily life (work related or not), try to pick one potential stock that you think you should do further study on.
4) contradictory to normal belief, diversify does not reduce risk nor give good return.
People has been told, in many many years, that diversify is the best strategy. The concept is that you can make up your loss at other area. As mentioned in last section, people actually win Nobel price for this. However, if you look at current economy, many things are interlinked and countries are trading and depending on each other. I believe blank diversification does not work anymore.
If you look at Buffett's investment, his profolio is actually highly concentrated. He did not go out and buy many major stocks in each section. Most of his return is actually comes from a handfull of stocks.
Instead of blank diversify, I think you should do smart diversify like this :
-- 60% of your stock investment should be in companies and market that you know about (see Point #3 above);
-- 20% in developing market (so called BRIC). We will talk more about this in Sec 4.5;
-- 10% in IPO stocks (more about this in Sec 4.4)
-- and 10% in the risk pool, as mentioned in Point #1 above.
