10 rules before investing in the stock market

How to invest in the stock market?

If you are considering to become an investor in the stock market, you should check these 10 main rules:

1º Never use credit

The stock market has, by itself, enought risk already. The maximum loss you can take in stocks is all the investment made. If you use a loan, in the worst case cenario you end up in a negative position instead of zero, plus interest to keep paying. It will become riskier and you might have to sell stocks at a bad timing in order to honor your credit conditions.

You should only use a certain amount of your savings.

2º Always have liquidity 

An investor should only use savings to invest, however, first you have to garantee you have enought liquidity.

And by enought liquidity, I mean you have to have enought money in your account that assures you will not have to sell any stocks to face unexpected expenses. I would recommend first to have six months of liquidity in your account and only then you should start saving and investing in the stock market.

3º Always diversify

Basic and one of the most important rule of how to invest in the stock market – DIVERSIFY!

When investing, the best way to reduce your portfolio risk is to diversify.

Always remember to “Never put all the eggs in the same basket”.

You should look for stocks in different sectors, different industries and even differents stock markets and pick your companies wisely.

4º Set your target

Why are you investing? Are you investing to assure retirement? Or your kids education? Or simply just to make more money in he stock market?

These are the type of questions you have to make to yourself and then set up your target.

A financial advisor can help you in this process and is highly recommended, but that doesn’t mean you don’t study and do your own research, i recommend you to learn and read some books about the stock market that teach you how to invest, like The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition) (Collins Business Essentials), and available in kindle The Intelligent Investor, Rev. Ed (Collins Business Essentials).

5º Know your stocks

Before you start investing in the stock market, you must define your asset allocation, you must study and do some stock market research, prepare a check list to screen for stocks, look at their financial ratios and know it’s fair value. To learn more, Finance for Executives: Managing for Value Creation is a must read, and available in kindle version Finance for Executives: Managing for Value Creation.

6º Make a plan

Define an investment strategy, the asset allocation and its proportion, compatible with your target and your risk tolerance, in order to achieve the best return with the minimum risk. Planning makes all the diference and it’s important to do it properly.

To learn more about how to invest in the stock market and making an efficient portfolio Modern Portfolio Theory and Investment Analysis is a must read, available in kindle version Modern Portfolio Theory and Investment Analysis, 9th Edition.

7º Envolve your family

If you are married and you have a family, you should discuss and plan together, adjusting your target and portfolio risk to the couple risk tolerance.

8º Follow your plan

In the short term, market does a “random walk”, and only in the long term it is possible to take conclusions about your portfolio and see if you are reaching your target.

And if you don’t follow your plan, you will never be able to say it works or that your strategy needs some adjustments.

Avoid doing this

 

9º Performance evaluation and adjustments

After a certain period of time, you should evaluate your portfolio performance and compare it with the benchmark (if you are investing in the American stock market, you should compare your portfolio performance with the S&P 500, for example). One way to compare performance is using the Sharpe ratio,

Sharpe ratio = (portfolio return – risk free) / portfolio volatility

Then you should adjust your plan if necessary and rebalance your portfolio.

10º Emotions out

Very important if you are investing in the stock market, be rational, protect your portfolio from your emotions.

When you have your money “on the line” it’s easy to lose control and rush to a bad decision.

News do not help either.

You must focus on your target and always follow your plan.

“…That would come as a positive surprise to the markets and reverse their mood – and markets do have moods; that is what the authorities have to learn.”

Soros, G. Financial Times online. 25/01/2012

Remember, keep calm, keep it simple and invest

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António Ramos

Financial Analyst

(CEFA holder)

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