Most investors want just one thing: to find a good stock that will go up forever, starting now. And for anyone who was investing over the past seven years, your wish has probably come true on many occasions. With the All Ords up 80% since the lows hit in 2009, luck has been on your side.
Relying on luck, though, isn't a sustainable strategy. So, while the sun is shining, how can you tell if your returns over the past few years are due to chance alone or because you’re a genuinely good investor? You can never really know, even after long periods, but here are a few signs you're on the right track.
1. You buy productive assets. If you think of stocks as ticker symbols bobbing around and decide whether to buy or sell based on price movements or what a chart looks like, that’s speculation. If you’re making money by trading currencies and commodities – rather than valuing businesses or property – you’re probably just getting lucky. Few investors, if any, can consistently make money by making macro-economic predictions, but plenty have got rich by buying high-quality, cash-generative businesses when they are undervalued.
2. You’re adequately diversified. Owning 10–20 stocks is enough diversification for most portfolios and reduces your exposure to company-specific risks, while still ensuring that you're concentrated in your best ideas. But good investors don't stop at counting the number of stocks. They also ask themselves whether they are exposed to a single sector or set of risks. Having half your money spread across each of the big four banks doesn't count as a well-diversified portfolio.
3. You focus on price. Now we’re really starting to separate the wheat from the chaff. The most important variable in any investment is the price you pay. If you are focused on valuing a company and figuring out the probable yield it will generate, you have the right mindset. Good investors aren't willing to overpay. They have a line in the sand and know that great businesses become poor investments if they pay too much.
4. You think long term. One thing that distinguishes good investors is that, before a purchase, they ask themselves whether they would be content to own that company if the stock exchange closed and they could never sell. If you were going to buy a farm, you wouldn’t be thinking about how much you could sell it for the next day, you would want to know how much wheat it could produce and how its earnings might fare over many years. The same should go for stocks because the intrinsic value of a business is based on all the cash it’s going to throw off between now and judgement day. Remember, trading is the enemy: the more regularly you trade, the quicker fees and brokerage expenses will clock up and eat into your returns.
5. You admit to not being up to the challenge. Good investors stick within their ‘circle of competence’. If you don’t have the time or desire to research stocks, there’s nothing wrong with that. Stick your money in a broadly diversified, low-cost index fund and you’ll outperform most active managers. The investors that get themselves into trouble are the ones that think they know more than they do. Good investors wait for the ‘fat pitch’, as Warren Buffett would say, and stick to simple businesses they understand. They don't swing at every opportunity thrown their way.
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