“The market” isn’t inhabited by just one kind of animal.
Instead, it’s like an ecosystem full of many different creatures, each with their own preferred ways to strive and thrive (or not).
Investors come in many shapes and sizes. From huge financial institutions to ordinary people. From the very wealthy, to those of more modest means. From short-term speculators who want instant results to multi-generational foundations with ultra-long-term plans.
All these distinct market animals have different aims, tolerances for risk, investment horizons, levels of knowledge and experience, and amounts of time and resources to dedicate to investing.
What’s right for one may not be right for another. Which begs a question. How do you decide what’s the right approach for you?
The world of investment is full of jargon. Growth investing… momentum trading… technical analysis… options strategies… structured products… hedge funds… value investing…
To name a few. It’s easy to get confused, which makes it hard to take the first steps into the investing world. But you need to realise that you don’t have to do the same as everyone else. You just need to work out what’s right for you.
For my own part, I’ve spent nearly three decades involved in the worlds of finance and investment. Over that time, I’ve learnt about all sorts of complicated strategies and investment theories.
In the end, a number of years ago, I concluded that all private investors need to bear in mind is a handful of fairly simple guidelines. That’s whether those investors are mega-rich or of more modest means. There’s really no need to overcomplicate things.
That’s not to say that other strategies can’t work. It’s just that they usually require large amounts of time and/or high levels of expertise that most people simply don’t have.
Whereas I believe all my approach requires is a consistent approach – guided by a handful of basic rules – and the patience to see investments through.
That last point is crucial. Patience is paramount. Despite what many people may think, investing isn’t a get-rich-quick scheme.
Investors that have that mindset are unlikely to last long. They might have a lucky speculative run for a period of time. But sooner or later they’re likely to suffer a vast loss.
Of course, some investments do deliver fast and substantial profits, even if you take a more measured approach. But they should be considered the exception, rather than the rule.
Instead, successful investing is best thought of as a potential get-rich-slow scheme. It takes consistency and patience to thrive in the investment world, over the long run.
Sticking to the fundamentals
At heart, I’m what finance people call a “fundamentals guy”. That means I’m more interested in the available facts about an investment than big stories or current fashions.
When it comes to investing in shares, the facts include the nature of a business, what it sells, where and to whom. Facts also include a company’s past profit record, how much debt it owes, who manages it, who its competitors are, and whether it usually pays cash dividends to investors.
Those are some of the things I’ll assess when looking at shares of companies. I believe it’s essential to focus on these fundamentals before even considering an investment.
There’s a good reason for that, illustrated by the following.
You may have heard of a famous investor called Benjamin Graham. He was Warren Buffett’s mentor and wrote a book called The Intelligent Investor, which is still revered today. He summed up what it means to be a fundamentals guy in the following quote:
In the short-run, the market is a voting machine, but in the long-run it is a weighing machine.
What Graham meant is that stock market prices can go anywhere in the short run, driven by speculative sentiments, investor emotions and the mob mentality. But, in the end, things come back into balance and the underlying, fundamental forces win out.
As someone that’s focused on fundamentals, I’m also focused on value for money. What that means is that I hate overpaying for investments.
At worst, I want a fair price. Ideally, I want a price that’s dirt cheap. As Buffett once put it: “Price is what you pay. Value is what you get.”
When sentiment is gloomy, market prices can be driven down to huge discounts to any reasonable assessment of underlying value. At the other end of the scale, market euphoria repeatedly leads to speculative bubbles in fashionable niches. Both situations are market facts of life.
Of course, assessing the fair value of investments isn’t easy in practice. It requires various financial analysis techniques, rational thought, common sense (which is pretty uncommon) and a lot of experience.
A key point is this. If something’s value, reached using a reasonable assessment, places it far above the current market price, the chance of a happy future outcome for the investor is significantly improved.
On the other hand, something that’s already priced for future perfection is far more likely to disappoint or even result in a loss. Which is why I always try to avoid those sorts of things.
In investment lingo, the gap between a (lower) market price and a (higher) value estimate is known as the “margin of safety”.
One way to think of the margin of safety is that the price discount will eventually disappear, meaning the price will rise to fair value, yielding a healthy gain.
Another way to look at it is that, if the price is already so discounted to value, it’s less likely to fall than if it was trading higher, with no discount. This means the risk of loss is lower than otherwise, all other things being equal.
Yet another angle is that if the value estimate turns out to be too high for some reason, it doesn’t matter too much since it’s already reflected in the lower price.
In other words, when an investment has a “margin of safety” built in, profit potential should be enhanced while risk should be moderated somewhat. That’s certainly a happy situation to be in (although it’s certainly no guarantee of success).
That’s why I focus on fundamentals… on value… on margin of safety…
But, because there are no certainties in investing, it’s also crucial to spread risks across a sufficient variety of different investments. Not even Buffett – probably the world’s greatest living investor – gets it right every time.
Some investments will do worse than expected, some will perform roughly in line with expectations, and some will do better than expected. The important thing is that they do well overall, on average and over time.This approach is the crux of the new project I have spent the last six months developing with Nigel.
It’s a way to put everything I have just told you into practice.
If you’re ambitious about your financial future, and you’re looking for regular, deeply researched investment recommendations, I think you’ll like what we have prepared for you.
In fact, I’ve created a wealth-building blueprint for 2021, following the principles that have worked for me over the last two decades.
If you’re interested, Nigel has recorded a video message telling you all about it:
Investment Director, Fortune & FreedomPS There are areas of the market I just don’t like the look of right now. Three assets in particular would make me sweat if I owned them. If you have money in the markets, there is a good chance you own at least one of these three “danger zone” investments yourself. When you watch Nigel’s video, you’ll automatically receive a timely report I have created called “Three assets to avoid at all costs”.