|Understanding Market Fundamentals|
Warren Buffet may be one of the best investors, even though he will likely not admit it. He claims that his success is due to the skills he learned from his mentor Benjamin Graham. Benjamin Graham was one of the forefathers of financial investing, specifically for value investing and security analysis. From Graham and Buffet’s success, there emerge three powerful yet fundamental principles that can help you make the most of your investment strategy.
Principle #1: Safety Margin
The first principle is investing with a safety margin. This involves buying a security at a significant discount. This can help provide you with higher returns, but also at a lower risk. If you can get an asset worth $1 for only $0.50, that is a good investment with a strong safety margin.
These investments have value because they are stable earners, and also because they are liquid. The idea is to have stocks whose liquid assets have more value than the total market cap. This exemplifies the adage, “the parts are worth more than the whole”. In the end, you are essentially buying companies for free. In the seventies and eighties, corporate raiders would gain control of a company and then sell off its components and vaporizing the original company. One doesn’t have to do that necessarily. Often, those parts can be optimized thus making the whole company worth more.
This idea is important since this style of investing allows for large profits once the stock price is re-evaluated. If the business fails, you still have some level of protection since you bought the stock at less than it was worth. In general, however, further decline in these stocks happens rarely, and thus, they are a relatively safe bet.
Principle #2: Earning from volatility
The second principle is about learning how to profit from volatility. There is an inherent instability of investing in stocks. While less experienced investors will be scrambling to get out when a market starts faltering, a smart investor can find good investments during this time. A smart investor is both a seller and a buyer. J.P. Morgan once said “There is money to be made when there is blood in the streets”.
It is important that you do not let the stock market run you and make your financial decisions for you. Make your decisions based on how much you believe a business is worth after you have analyzed it. You should buy when the market is down and sell when it goes up. The market is always going to change, and if you keep your head up, you can use this to your advantage and buy bargains.
There are two different ways of implementing this strategy. Dollar-cost averaging means buying investments at regular intervals for the same amount of money. You can take advantage of price drops this way, and you will not end up buying all of your investment at the highest price. The other strategy is to invest in both stocks and bonds. By having a portion of your investment in bonds, you can help protect your capital. You will also be less tempted to get into speculating with the hopes of seeing a huge profit.
Principle #3: To thy own financial self be true
The third principle involves knowing yourself as an investor. There are two main types – active and passive investors. This means you have two basic choices – make a commitment of time and energy to gain the experience you need to become a great investor and find higher returns – or be content to invest in lower risk and lower return investments that require less work for you. With this philosophy, there is a direct correlation between the amount of work you put into investing and the amount of money that you can earn from it.
If neither style fits you exactly, then index investing is a good option. This will help you get an average return with a defensive strategy. Remember, not all of us have the same philosophy about making and keeping money. Some focus only on making more while others concentrate on keeping what they already have. The best attitude blends those two objectives since by themselves, neither one is completely sound.
Warren Buffet, one of the richest men in the world, built his financial empire upon these three solid investing principles. With thoughtfulness, research, and financial steadiness, you can also garner tremendous profits from the stock market.