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investing in stock market

35 Rules of Common Sense Investing

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I have been investing in the stock market for nearly ten years and acquired quite a bit of experience and knowledge (mainly through making mistakes). I’ve never codified on a piece of paper until today. Before I begin, I want to give credit where credit is due. This post was inspired by CommodityWorld.com’s Common Sense Rules for Traders. Moreover, these are personal rules — so pick and choose what you like and ignore the rest.

investing in stock market

#1 – Pay off your debt before you invest.

Clean up your finances before you invest. If you owe any consumer debt (e.g., credit cards, personal loans, or car loans), you need to get rid of them first. These debts are expensive and rarely offer any benefit. When you pay them down, you are guaranteed to save money on the interest. The only exception is productive debt like home loans and business loans.

#2 – Set up an emergency fund.

Keep a small amount of cash that you can use for emergencies or other opportunities. To get started, you should have at least $1,000 set aside in a high-yield savings account. As you get more established financially, a good goal is to set aside 3-6 months worth of living expenses to deal with any unforeseen circumstances.

#3 – Do your homework.

Do not invest in the stock market until you understand how the stock market works, different investments that you can choose from, and the risk that you’re taking on. If you are eager to jump in, stick to the basic investments like a broad market index ETF or a target retirement ETF.

#4 – Know your limits.

Understand your risk tolerance and formulate your investment strategy based on your risk profile, goals, and time horizon. The market goes up and down all the time, and some investments are extremely volatile. Don’t buy an investment that would cause you to panic sell — that is how you lose your money.

#5 – Have an investment plan.

Once you complete #1 through #4 above, you are ready to start investing, you need to put together a plan. Always remain true to your plan and follow the style that works best for you.

For example, my investment plan is very simple. I contribute regularly to my investment accounts and the money gets invested according to my asset allocation percentages. I only use a handful of low-cost index ETFs to build my portfolio. Whenever the percentages deviate from the allocation goal, I rebalance the portfolio by selling investments that made recent gains and buying investments that are lagging behind.

#6 – Do your research.

Never buy and sell if you do not understand what you are buying or selling. If you want to invest in individual stocks,  you need to learn how to perform fundamental analysis and read the Cash Flow Statement, Balance Sheet, and Income Statement. And you better damn well know what the hell you’re doing, if you want to trade options, do short sales, trade leveraged funds, or trade on margin.

Or you can keep it simple like I do and just stick with the basic index ETFs with simple asset allocation and rebalancing strategy.

#7 – Stick with liquid investments at the beginning.

Limit your exposure to illiquid investments, such as precious metals, jewelry, collectibles, antiques, ownership of a private company, commercial real estate, etc. While some of these investments can be very profitable, they are difficult to sell at the fair market value when you need to sell quickly.

Investments such as stocks and bonds give you greater flexibility and have excellent historical performance.

#8 – Time is money.

The more time you have to invest, the more money you will make — this means you should start investing as soon as you can.

Do you realize what difference a decade makes? A person needs to contribute about 3 times as much money to catch up to a person that starts a decade before him!

Read more here: How to Become a Millionaire by Investing $100 a Month.

#9 – Be patient.

You should never get into the market because you are eager to jump in, or you have a “Fear Of Missing Out” (FOMO). Conversely, you should never get out of the market because you panic or lost your patience. Like the great Warren Buffett said,

Be fearful when others are greedy and to be greedy only when others are fearful.

#10 – Buy and Hold.

Do not be an active trader. Historically, the market always goes up in the long term. However, there are a lot of ups and downs in the short term. As an active trader, you are guaranteed two things:

  1. You will pay more trading fees. Even with $0 commission trades, you’re still paying a small amount of bid/ask spreads, SEC fees, and TAF fees with each trade.
  2. You will pay more taxes (e.g., short-term vs. long-term capital gains).

#11 – Mind your taxes.

Investments that pay high dividends or make big distributions should be invested in your tax-deferred or Roth accounts. Examples of these investments include bonds, dividend stocks/funds, and REITs.

In taxable accounts, make sure you regularly look for tax-loss harvesting opportunities to offset your gains. And when you’re taking profit, be sure to wait at least one year and one day so you can pay the lower long-term capital gains tax rate.

#12 – Keep your costs low.

When it comes to investing expenses, even a 1% expense can really dig into your gains. The good news is you can easily manage your investment expenses. Here are some ideas:

  • Use $0 commission broker instead of a broker that charges fees for trading, or a full-service broker.
  • Use ETFs instead of mutual funds.
  • Avoid funds and ETFs with a high expense ratio.
  • When you leave your job, rollover your 401(k) into a self-directed IRA. In general, a 401(k) plan has more fees and the available investments have a higher expense ratio.

#13 – Use Limit Orders.

You cannot control the price at which your order will be filled with a market order. A market order is okay most of the time, but for some investments, a limit order gives you greater protection from price fluctuation. Remember that your limit order may never get executed. If you want to use a market order, do so while the market is open.

#14 – Use Stop-Loss Orders.

Create a plan to limit your losses. For example, set up stop-loss orders at reasonable price limits; a good range is 10-20% below the current value depending on the volatility of the investment. When the price drops by a certain amount, the broker will automatically execute the stop-loss order for you, thus limiting your exposure to further price drop.

#15 – Lock in your profit.

Similar to the idea of limiting your loss with a stop-loss order, you can also lock in your profit using the same technique. As your investment price rises, you can increase your stop-loss limit to lock in the profit.

  1. Diversify. Divide your money into different investment vehicles (e.g., money market, stocks, bonds, mutual funds, ETFs, etc.), as well as various asset class (e.g., large US companies, small US companies, global, etc.) and sectors (e.g., financial, utilities, technology, etc.) based on your time horizon and risk profile. Never risk more than 10% of your capital on any one investment, especially an individual stock.
  2. Reallocate once a year. Different investments will grow at a different rate and throw your asset allocation out of whack. It is a good idea to rebalance your portfolio at least once a year, or more, depending on the degree of misalignment and expenses involved. Alternatively, use poor man’s reallocation by adding new money to this year’s poor performers.
  3. Manage your risks. In addition to diversification, do not risk the money you will need in the near future in high volatility investments.
  4. Be wary of a bargain. Never buy just because the price of the investment is “low” or sell just because the price is “high.” Study the factors that are driving the price and why. Buy and sell based on your research.
  5. Stay your course. Never change your investment strategy without a good reason. If you did your research and executed accordingly, everything should be fine despite short-term setbacks. If your investment drops significantly, the stop-loss order will take care of you. Never let greed or fear take control over you.
  6. Don’t try to time the market. Do not guess where the top and bottom of the market is. Do not be afraid when the market, or your investments, reach all-time highs or lows. Market timing myths like the January effect and October effect are not real. Use your strategy and research as a guide.
  7. Don’t believe the hype. Do not listen to the news and believe everything that is said, instead use your strategy and research as a guide.
  8. Never sell into a panic. Self-discipline is your friend when the market goes against your position. Do your investments become unsound just because the market tanked? A lousy market does not make your investments bad.
  9. Don’t pile your bet on the winners. Avoid the natural tendency toward increasing your position in successful investments. Let your winners ride and look for more winners.
  10. Don’t throw good money after bad. If your investment is diving, do your research and understand why. Do not just keep piling in money to cost average down; something may have changed since you last did your research.
  11. Regular contribution is your friend. If you have a big chunk of money, don’t use dollar-cost averaging. It’s usually better to invest it all instead. However, do regularly contribute to add new money to your investments.
  12. Avoid taking small profits and big losses. Do not sell your rising star just because it doubled in a few days. Do your research. If it is still a good investment, keep it.
  13. Reinvest for success. If your investment pays a dividend or distributes capital gains, reinvest that money. You can participate in an automatic reinvestment program to avoid any minimum investment rule or trading fee.
  14. Find your magic formula. If you have expertise in a particular area, leverage it to boost your chance of success. If you figured out something that works, stick to it. That is until you can find a better magic formula.
  15. Not all investments are created equal. Do not treat all investments in the same way. Learn their specific characteristics and choose the right tools for the job.
  16. Look through other people’s eyes. Try to understand why a buyer would buy and why a seller would sell. This will enable you to be more flexible and maximize your potential gain.
  17. Learn from your mistakes. Do not fret, but never let a mistake pass without learning from it — ask yourself what happened and why. If possible, keep a log of your investment activities — e.g., why you made them, what happened and why, etc.
  18. Avoid trading on margin. Always invest within your capabilities. Trading on margin is a risky business. At the least, you are guaranteed to lose the interest on the money you borrowed.
  19. Be flexible. As your knowledge grows and time changes, be ready to reevaluate everything and alter your plan.
  20. Have fun. Finally, have fun investing! Here is $1,000,000 in play money to try out your investing strategy — it’s free, and you can earn money.
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traineeinvestor
13 years ago

That’s an interesting list and provides a lot of food for thought. However, I’m not sure if I would agree with all of the items on the list. In particular: #1 if you mean pay off expensive consumer debt, I agree. If you mean pay off debt used to acquire assets, if the cost of debt is less than the expected return, then keeping a manageable level of debt can be a good thing; #6 illiquid investments can be very profitable. The key is to make sure you have enough liquidity in your portfolio to ride out any rough patches;… Read more »

Pinyo
Pinyo
13 years ago

Trainee Investor – thank you for your very thoughtful comment (and nice blog by the way!). I agree with you absolutely. These rules are very generalized. Here’s some more thought on some of the points.

#1: I should clarify as bad debt – i.e., credit card, high interest loan, etc. It would not be wise to wait to pay off your home mortgage before investing.

#6: Yes, very profitable but not for typical investment beginners. You need a certain level of expertise to work with illiquid investments.

#15: Agreed.

Cheapster Bob
Cheapster Bob
12 years ago

Nice information and I agree with most of them for active traders. However, I like to keep things easy and dumb.

Have a month or two earnings in a high yield savings account.

Invest in your companies 401K to the max.

Invest in a good traditional or Roth I.R.A.

If you still have money left buy a simple S&P type index fund making regular auto investments.

Stock trading usually loses to mutual funds which loses to the S&P index 80 percent of the time.

That’s just my opinion though…

Welcome to Paradise
12 years ago

This is quite an informative post. I agree with most of them. I’ve made a copy of this post. I hope to utilize them in my daily routine.

Thank you.

Personal Finance HQ
Personal Finance HQ
12 years ago

Good tips there. I’d be interested to hear how your rules have helped you out during the recent market turmoil. Have you learned any new lessons? Or have recent developments shown the strength of your strategy?

Certainly for me, stop losses got me out of a lot of stocks fairly early in the drop. I then had the cash to buy back as things started rising again last week. I just hope this ‘recovery’ holds :-).

Jarkko
9 years ago

Clean up your finances before you invest… Yep.. Normally people invest more when they need more (to pay their debts), but that is not the case. It has to be reasonable.

Michael L. Snodgrass
Michael L. Snodgrass
8 years ago

It’s kind of funny, but I woke up early this morning and just started writing down some of my investment strategies. Then later this a.m. I Googled a search to read others’ investment philosophies. Your ideas and mine pretty much paralleled each other (of course, your list is much longer.) I am keeping your list because it is so simple and applicable. Thanks!

Jonathan
Jonathan
7 years ago

A big yes to number 1!!!! Paying down debt before investing should always be a priority especially as most debt interest rates are higher than investment rates, which remain exceptionally low at the present time.

Amir Sibboni
Amir Sibboni
6 years ago

Great tips thanks for the information

BERTINA
5 months ago

In 2008 I lost all my money in the stock market and ended up being poor and living on the street, if you had met people like you nothing would have happened to me.
God bless you

35 Rules of Common Sense Investing

by Pinyo Bhulipongsanon time to read: 8 min
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