Investing in stocks can be confusing.
How do you know which ones to pick? How can you be sure that you won’t lose money? Should you follow hot tips from a colleague?
These are some of the reasons why most people in the developed world do not invest, choosing instead to let their savings dwindle away from the effects of inflation. You’ll hear them try to justify it by saying things like:
“I may only be earning a 1% interest on my savings, but at least they’re safe in my bank account. Besides, investing takes years to really master!”
If you want to step away from financial mediocrity and actually start making your money work for you, I have a couple of tips for you. 😉
It’s Not That Hard!
Ok, I’ll admit it: I used to be intimidated by investing and the stock market.
Although my dad’s job was to pick winning stocks for his investment fund, I still knew surprisingly little about stocks.
I saw Hollywood’s representation of investing in films like Wall Street, American Psycho, and more recently, The Wolf of Wall Street – one of the best movies from the last decade, hands down.
These films show power-hungry stockbrokers selling smoke to people and furthering the idea that you have to be some sort of magician and beat the stock market in order to be successful and make money. No normal person could ever do that!
It’s things like these that perpetuate the idea that the stock market is a glorified lottery: a place where everyone hopes to become a millionaire overnight but has huge risks.
You’ll also hear stories from friends, claiming that their uncle once invested in the stock market and lost all his savings. Perhaps a colleague of yours once invested in a tech company during the “.com bubble” and got burned, pledging to never, ever risk her money on such a gamble again.
Well, I’m here to give you some good news.
Having amassed a 6 figure stock portfolio myself which generates hundreds of dollars in dividends each month, I can tell you that it really, really, isn’t that difficult!
All you have to do is keep it simple and follow the 80/20 rule.
The 80/20 Rule and Investing
The 80/20 rule, also known as the Pareto principle, basically says that 80% of the effects come from 20% of the causes.
This principle applies to a surprising amount of areas in life. It has been observed that in weight training, 80% of muscle growth comes from 20% of exercises. Additionally, the Dunedin Study saw that 80% of crimes are committed by 20% of criminals.
I could pick examples all day long. This is a real phenomenon that exists everywhere, and investing isn’t any different. Stick to the basics – the things that really make a difference – and you’ll mostly be absolutely fine.
Here’s what you should focus on:
1. Do your due diligence
Buying a stock isn’t like buying something with no inherent value like a lottery ticket. A stock represents a small slice of a real company.
A company with assets, employees and cash reserves. A company that has been successful enough to actually make it into a publicly traded company, which is no small feat!
In other words, there is backing to your stock. It represents something real and of value – “value” being the key word here.
However, you cannot buy any stock at any price and expect great returns from it.
There are several requirements that I always look for when considering buying a company’s stock. These help me to work out the correct value of the stock – the point at which it would make sense for me to buy it.
I always look at a company’s numbers over the last 10 years or so to get an overall picture. I look at how their revenue, earnings per share, dividends and debt have progressed over that time.
If these are good, it’s is often enough to give me a decent impression of a company, which then allows me to calculate a fair entry price.
If you wanna know how to work this out yourself, step-by-step, I’m currently creating a course on Dividend Investing, so pop your info below to be added to the waiting list and get updates on it!
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Remember the horror stories I mentioned earlier?
I didn’t just make them up – I have actually heard them from real people haha! What they all have in common is not following one of the basic rules of investing: Diversifying.
If all you own is one stock, you’ll be at the mercy of this one company. You’ll ride their highs and endure their lows.
Imagine if you made a bad pick and bought it at a high price as well… You could easily lose a lot of money if things went south and the company went bankrupt – not that it should, since you should have followed step 1 and made sure the company was up to scratch! 😉
To combat this, you must diversify.
As John Templeton once said:
“Diversify. In stocks and bonds, as in much else, there is safety in numbers.”
You should own stocks in different sectors, doing different things so that they’ll be able to balance each other out.
Imagine you owned stock from 20 different companies in different sectors: energy, consumer goods, healthcare, utilities, technology… Then the worst thing happened: one of the companies of which you own shares declared bankruptcy and you lost all the money you invested in it.
Gone. Just like that.
Well, as long as the other 19 companies were up in value by the historical average, you would still have made money overall that year!
This is huge.
Knowing that even if the worst thing happens, you’ll still be fine is a massive psychological boost. So…diversify!
3. Be patient
The last one of the basics is psychological, which means it’s difficult to overcome.
This is actually where most people fail at investing. When they see their stocks dropping in price, they experience one of humankind’s most basic emotions:
They then panic and sell all their shares, hoping that they won’t lose all their money. Then a few weeks later, the stock price goes back to normal and they’re left with hurt feelings, a negative perception of the stock market, and a crippled net worth!
When you’ve been investing for a while, you’ll experience times when some of your stocks plummet in value. It happens.
I remember back in 2014 after China had just announced that its economy wasn’t growing at the pace it expected, my portfolio dropped by 12% in one day.
Seeing your hard earned savings drop by that much wasn’t easy to bear. This meant a loss of thousands of dollars – several months of being frugal and saving a large chunk of my salary.
Luckily I came prepared and expecting that this would happen eventually. I then stopped worrying and carried on living my life! A couple of weeks later, everything was back to normal.
It really helps to know the historical trends of the stock market when fear strikes. Check out this graph:
These figures take data from the S&P500 during 1926-2011 and show something awesome.
Firstly, if you plan on selling before 5 years, you probably should not be investing – especially if you’re gonna need the money for something. These figures show that it’s likely that you’ll have losses due to how volatile the stock market can be – in the short term, at least.
Here comes the good part, though.
Wait for 10 years or more, and it’s pretty darn difficult to incur overall losses. After 20 years, the figures say that you have a ZERO PERCENT chance of losing money.
That’s insanely awesome!
It’s basically telling you that, as long as the stock market continues to perform similarly to the past century – where there were plenty of major recessions and huge wars – you’re pretty much guaranteed to make a profit, even in the worst-case scenario.
If your time horizon is even longer – as in, when you plan on selling, if ever – then you’re even more likely to experience the amazing gains that the stock market has been giving investors for over a century.
Just Focus on What Matters
If there’s one thing I want you to take away from this article, it’s that you really need to use the 80/20 rule. Use it at work, use it with your health, and definitely use it with your finances and investments.
Don’t be put off by all the tiny details in investing – these will only account for about 20% of the results anyway. Focus on the really important parts (due diligence, diversity and patience…) and you will be fine.
Actually, you’ll be more than fine.
You’ll be freaking awesome because your money will grow exponentially and you’ll be receiving a stream of never-ending passive income through dividends!