[Editor's Note: This essay is adapted from "Fiscal Hangover," which will be published on Monday (Nov. 16).]
With all the financial woes in the global economy, the worst thing an investor can do is to "freeze up." With all the ups and downs in the market, it's all too easy for investors to allow their emotions to take control. That's when the smallest mistakes turn into the biggest mistakes.
There's one antidote for this problem … remembering a few basic rules. Just embrace the 10 ideas that follow and you'll be in line to make some serious money in the months ahead.
Rule Number 1: Invest on the Right Side of Major Economic Trends: That old investing adage "Don't fight the Fed" serves as a good example here. Rising interest-rate environments make meaningful gains difficult to sustain – unless you know what to look for. Far too many investors got it wrong in the 2000-2003 and 2008-2009 periods by betting on growth stocks in a recessionary economy, and they're still getting it wrong. Those investors are likely to get burned again should the economy slow even more, despite the government-bailout and federal-stimulus efforts. Make sure to analyze all of the other major global trends, as well – and ride the ones that are truly unstoppable. You'll know them when you see them, because they'll have trillions of dollars in new capital flowing directly at them – investment plays in such areas as infrastructure, inflation, energy, food, and water (both supply and purity) are great examples.
Rule Number 2: Sell Your Winners: This may seem counterintuitive, but – if you want to succeed – you must sell your winners. Rule Number 6 – thinking like a plumber to prevent losses – is only part of the success equation. To be really effective, you have to take profits, too. That way, you get more capital that you can put to work. Think of it this way – Safeway Inc. (NYSE: SWY) regularly replenishes the inventory in its Produce Department to keep it fresh. You should do the same with the "inventory" in your portfolio because, if you let your stocks sit on the shelf too long, they'll eventually go bad – just like fruit that's past its expiration date.
Rule Number 3: Always Sit in an Exit Row: This rule goes hand in hand with Rule Number 2. One of the most common problems investors have is not knowing when to sell. Sometimes, they'll let a big loss get out of control (which violates Rule Number 6) – or, worse, they'll notch a big gain and then sit on the investment so long that it sneakily turns into a loss. The bottom line is that, up or down, you should always have planned exit pointswhen you initiate a position – and enforce them with "protective stops,"adjusting them as prices move in your favor (but never when they go against you).
Rule Number 4: Your Broker is a Salesman. So unless you know you want to buy what he has, don't go shopping today! Wall Street is not a service business. Brokers exist for one reason and one reason only – to sell you stuff and make money . . . from your money. And the more of your money you give to them, the less you have to make more for yourself. So buy only what you want and what fits your goals and objectives – not the "stock of the day " the broker is pushing to meet his weekly quota.
Rule Number 5: Invest for High Yields:Contrary to popular belief, rather than investing for capital gains, you should aim for the highest possible yields and the most certainty you can find. The real secret to wealth-building is compounding small gains over long periods of time. In fact, studies show that compound returns can outperform so-called "growth stocks" by as much as 22-to-1. Furthermore, dividends account for a huge percentage of total returns – varying studies have claimed anywhere from 60% to as much as 97% over time. So, don't ignore them!
Rule Number 7: Buy Value: Buying when the underlying value is "right" can mean the difference between pathetic single-digit gain and truly market-beating returns. It's hard to make money when valuations – as reflected by Price/Earnings (P/E) ratios are greater than 20. More normal valuations sit in the 12 to 14 range. However, to reallymake money, you need to buy when valuations have been beaten down into the single digits – assuming, of course, that the company's underlying value is real. Doing so puts the odds strongly in your favor and can dramatically boost returns.
Rule Number 8: Retirement is a Lifestyle Issue, Not a Monetary One: When most people think about retirement, they think about safety. Big mistake. The single biggest problem facing us today is running out of money before we run out of life. If you've followed Rule Number 9, this shouldn't be a problem. However, if you've thought about safety and have not invested enough, what you're really doing is crippling your ability to earn future income – income you're going to need in order to eat, keep a roof over your head, and provide lifelong life health care. Oh yeah, and have some fun.
Rule Number 9: Start Early and Leave Your Money Alone For as Long as Possible: This is not the same thing as "buy-and-hold" investing. Buy-and-hold is not an investing strategy, it's a marketing gimmick – and, these days, it's more like "hope-and-pray" investing, anyway. The world's most successful investors – think Jim Rogers, Warren Buffett and the late Sir John Templeton, to name a few – don't buy and hold. And I don't believe you should, either. These experts buy and "manage," confining themselves to stocks and strategies that meet their specific objectives. Given that one of our critical objectives is to have our money working hard for us rather than us working hard for it, the point is that you want to start as early in your life as possibleand never miss an opportunity to invest. The longer you have your money in play, the better you will be paid when you're ready to cash out!
Rule Number 10: All Investments Contain Risks – But Not All Investments Contain the Same Risks: Despite all my talk about avoiding losses, the simple truth is this: If you want to grow your wealth, you have to take on risk. It's unavoidable. Every investment involves risk – the only questions are how much and under what circumstances. Remember, success is not about how much money you can make, but about how much money youkeep. As such, the true secret of wealth-building is taking risk properly.
Indeed, the late legendary U.S. Army Gen.once said: "There is nothing wrong with taking risks." But he also cautioned: "That's quite different from being rash." I completely agree. What's more, I think that Patton would have agreed with my belief that if you want to be successful in anything, you have to take a certain amount of risk every day. It's just a fact of life.
Yet, most folks are unwilling to do so – or they spread themselves too thin, and over-diversify, all with the goal of "protecting" themselves. Unfortunately, by doing so, these investors actually set themselves up for failure – not because they take too muchrisk, but because they don't concentratethe risks they do take in the right places!
What are those "right" spots? They're the investments that can provide the potential rewards to justify the risks the investor has taken.
[Editor's Note: Keith Fitz-Gerald is the chief investment strategist for Money Morning and The Money Map Report. Fitz-Gerald has pulled all his best thoughts together in his new book, "Fiscal Hangover: How to Profit From the New Global Economy." The reviews are excellent. Investors interested in ordering the book can save $10 off the cover price at Amazon.com. Just click here.]
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