Introduction
Below is a list of ten investing rules for retail investors interested in investing in stocks. What this really is is a codification of basic investing rules for myself. They aren’t very complicated; in fact they’re really straightforward. I need to write them down so I don’t stray from them.
Because every time I do, I lose money. It’s as simple as that.
Let me start by saying I am probably not the most qualified person to write this. I do have a background in finance (many moons ago), I do have an MBA (again, many moons) and I do invest in the stock markets. My investment return has been pretty good (I’m too shy to share actual numbers) and I’ve had the good fortune of holding some of the best multi-bagger shares over the past decade (DPZ, RNG, ROKU, TSLA) from when they were tiny companies just starting out. BUT…I don’t do this full time, I’ve made many mistakes, and I did start from a pretty tiny base, so please take this for what it is.
The Ten Rules I Invest By
Below are the rules:
- Invest, don’t trade
- Buy what you use
- Buy Growth over Value
- Ride the stock
- Take (some) money off the table
- Buy on dips
- Just say NO to options
- You can’t time the market
- Journal your thoughts / trades
- Don’t be greedy; do be patient
1. Invest, don’t trade
This is pretty straightforward: unless you’re doing this for at least eight hours a day and can stay glued to your desk watching the markets through the entire trading day, day after day, you cannot be a trader. It just isn’t possible. So, be an investor. Invest your money with the longest possible time frame you can think of. My rule of thumb is at least a minimum threshold of three years (unless your investment thesis changes of course).
I wish I actually always listened to myself. Sometimes I get caught up in the market frenzy and buy stocks I know I shouldn’t and convince myself I will only hold them for short periods. Or I try and time the market and sell at what I think is going to be a peak, with the idea of buying again when it falls (ha!). Or I buy options (oof!).
Sometimes it does work – I got lucky by buying puts as soon as Covid happened and made money on that; but most of the time, I end up losing money (Yahoo puts when the stock went up 3x due to Alibaba value; sold immediately after Trump became President because I was convinced markets would crash; sold stocks into post Covid rally because I thought there was going to be a second dip / crash).
2. Buy what you use
This is the Golden Rule, the one rule to rule over all other rules. Ideally buy something you actually use (and like) – i.e. a company whose products and services you have direct experience in consuming yourself. I try and stick to the higher bar of actual usage as opposed to just knowledge of the product, but it isn’t always possible (e.g. biotech stocks), so at the very least make sure you understand them.
The rationale is as stupid as it is obvious: you might as well put your money behind something you already know and trust. If you love it, chances are others do too. If you’re interested in buying something, and don’t understand it, then your options are simple: a) spend the time to understand it or b) don’t buy it.
Most of my best stocks have been products and services I have used: I opened a bank account with First Republic and was so impressed with their customer service and accessibility I bought the stock in 2012 – and have held it ever since. I ate the new Dominos Pizza (DPZ) and liked the taste; more importantly, I loved their mobile web app for ordering and so bought the shares. I loved my Roku (ROKU) box for streaming content and so bought the stock. I found myself liking the suite of IP based communications we were using at RingCentral (RNG) in our company, so I bought the stock. See the pattern?
I did the analysis – and my return on stocks I use is 7.5 times greater the return on stocks whose products I didn’t use!
3. Buy Growth over Value
Much has been made over the difference between growth stocks and value stocks. As Howard Marks said, it’s a bit of a false dichotomy. I actually think his argument is pretty cogent, and its always worth reading it in full.
For me it’s much simpler than that: buy a stock because you think it has the potential to grow / become larger in the future; don’t buy it because you think it happens to under-priced at the moment. Put differently, don’t buy a stock simply because you think it’s cheap at the moment, because the best-case return in that situation is to make the delta between its current price and intrinsic price. Instead look at its future growth prospects relative to its current price: if you manage to find the right stocks, your returns are likely to be several multiples higher over the long-term.
The point is that looking at DCFs and other valuation metrics to see if a stock is under-priced is a limiting exercise, because you’re not getting a real sense of future growth (I always love how the end state growth rate in the DCF is the biggest determinant of stock price, but the one least thought of by analysts plugging the numbers in the models).
My ideal sweet spot is as follows:
- companies that have recently IPOed, or have had some sort of growth trigger event (e.g. new hot product, patent, acquisition, etc)
- have a market cap of < $10billion (not a strict requirement)
- are relatively unknown / under-followed by analysts (which means the true value hasn’t yet been fully realized)
Investing in early stage public growth stocks can provide the same kinds of returns you get in mid to late stage venture investing, with significantly less risk (since they are already public). The truth is that most hedge fundies and analysts, whilst being plenty smart, don’t know everything about everything. They just can’t. So if you have found a stock whose product you like and it happens to be relatively small, chances are you’re ahead of the curve. Customers and analysts will eventually catch up.
4. Ride the stock
This is probably the most painful lesson I had to learn. Most of the stocks I buy tend to be growth stocks – and hence have the potential to grow and grow and grow. Many, many times I have bought the stocks at the right time, but sold entirely too early – and then watched the stock continue going on its rocket ship ride to the moon. Just without me.
- I had many, many shares of RNG that I bought in 2013-14 for ~$13.50. I sold them all in 2016-17 when the shares doubled to about $30. It’s now at $313. Ouch!
- Same with DPZ: I first bought shares in 2010 for $11. I sold them in 2011 when they were at $25. I bought some more again at $33 and sold them in 2013 when it was $60. It’s now at $384.
- Just in case you think I learned my lesson, here’s what happened with TSLA last year. I bought the shares at $78 (pre-split) in March, right at the bottom of the Covid crash, and then sold them for $147 a month later. It’s now at $683 (and went as high as $900).
The logic is simple: if you’re buying growth stocks, let them grow! It’s a bit like venture investing as well – you’re kind of swinging for the fences, and hoping at least a few of them get there and become the next Amazon / Apple etc. If you have one stock that returns 10x over its lifetime, Selling them too soon because you think they’re overvalued defeats the purpose.
Here’s my rule for this: if they’re making money for you, and your perception of the company hasn’t changed, just don’t sell (ever) (or at least wait a minimum of three years). Am serious. Don’t sell because you think the market is over-valued. Don’t sell because you think the stock is over-valued (see my next section on taking money off the table). The only reason to sell is if you don’t think the company is executing well any more (typically poor products, new management team, poor acquisition, and most importantly, new entrant who will eat their lunch).
5. Take (some) money off the table
You can’t stay invested forever. And sometimes stocks do come down. However we all know it’s impossible to time the market. So – it’s important to take money off the table, but to do so non-emotionally, or programmatically. You don’t want to take all your money off the table because you want to keep riding, but it would be good to take some money off periodically (to invest in other stocks, or even to buy more of the same stock if/when it dips).
Here’s a good rough rule of thumb I use myself: if the stock price doubles, take out half the of your original investment. When the price triples (from its original price), take out the other half, so you have taken out your original investment amount. From then on, take out half the original investment each time it triples further. You can change the numbers, but the idea is simple: recoup your initial investment, let the rest ride, but periodically keep taking a bit off the table.
6. Buy on dips
If you have a basket of stocks you use, and are riding to the moon, do take advantage of market dips to load up a bit more. The truth is that the market will turn against you periodically, and if you have been good about taking some cash off the table, these dips can be great buying opportunities, and a great way to juice your overall return. I typically say you should buy when stocks dip at least 20%, and definitely at 30%. If you are buying growth stocks, this will happen at times, and if you have the patience to take the long view on them, these corrections are excellent buying opportunities.
7. Just say NO to Options
Just don’t. The only time options are justified is as a cheap hedge to your positions – but again, its probably easier to just say no. It’s too easy to get sucked into the idea that you can make easy money from options – and you read the WSB Reddit thread on the guy who made millions and millions on his option trades – and you think “Hey! I can do that!”.
You can’t. At least, I cannot.
Its true I got very lucky with a series of puts against the NASDAQ during the Covid crash and made a great return on them. But that was just luck, plain and simple. Outside of those trades, I have lost a lot more money than I have made on options. Put differently, of the 29 times I have made option trades, I have lost money on 19 of them and made money on 10. That’s not a great win/loss ratio.
The danger isn’t so much the option as the lure of juiced up returns that lies behind the options. I always get sucked into that and it’s just not worth it.
The next three aren’t so much investing rules so much as behaviors that I think help make for great investing (and help round this list up to 10 in total).
8. You can’t time the market
You can’t. Seriously. Just don’t. Every time I have tried, I have failed. I thought the markets were over-priced, I was wrong. And I paid for my mistakes by selling my stocks too early. I did this when Trump was elected President, and I did this after the initial recovery post the Covid crash. Each time, stocks climbed up 20%+ and I left significant money on the table.
My advice: just stay invested. If you’re looking at this for the long term (and you should: have a horizon of at least 10 years), then suffer through a crash. If you’re the cautious type, keep 10% of your portfolio in liquid / money market instruments, and when those crashes occur, use them as buying opportunities to buy more of the stocks you already own – or other stocks you had your eye on (subject to the rules above).
Margin can also be your friend – don’t be too afraid to use a little margin to take advantage of the buying opportunities created when crashes do occur. Wait a little longer than you think you should, and then wait a bit more: don’t buy the stocks on the way down, but when they’ve bottomed and are on their way up again (my rough rule of thumb is ~30% dip before jumping in, see Buying on Dips).
9. Journal your trades / thoughts
I have found this to be super super helpful. It is kind of ridiculous that a lot of people who actively invest will do so on pure impulse (ahem: me). It’s really stupid given that this is your money and life savings. At the very least it deserves some thought. The best / easiest way to force yourself to think through a trade or situation is to write it down. I don’t agree about everything that Ray Dalio says in his Pinciples, but I do agree you have to start by writing it all down. It provides a clarity and a history and a base upon which you can iterate and improve.
10. Don’t be greedy; do be patient
At least, don’t be greedy when everyone else is being greedy. As Buffet says, be greedy when others are fearful, but don’t get swayed by the story of the guy who bet it all on one stock and made a killing. That’s not you, and for every one of those monkeys, there are a thousand who did and lost it all. So just don’t.
I find not being greedy also gives you peace of mind. If you start thinking about how much you could have made and wishing your stocks higher, you get stuck in a horrible loop – and then tend to do really stupid things. So, don’t!
The equity markets are the greatest wealth creation machines in the history of money. No other asset has historically constantly gone up in the long run. Rightly or wrongly, the very nature of capitalism requires it to be so (grow or die). So don’t be in a hurry and always take the long view of things. You will almost always be richly rewarded.
I’ll leave with this anecdote: if I had just simply held on to the basket of stocks I had held at the end of 2014, I would have ended up with roughly the same current wealth today!
Summary
I’m almost reluctant to say this – but if I had actually stuck to my principles whilst investing my total return over the past decade would have been easily 3x what it is today. Not kidding – I did back of the envelope math around it. Hindsight is always 20/20 – but still – it tells you something!