2 key rules for investing in stocks

Investing in stocks can be a bumpy ride, especially if you have little or no experience. To help smooth out the size of the ups and downs here are two key rules.

Stock prices don’t always go up. Companies go bankrupt. Governments default on their debt. Financial markets are volatile and their movements aren’t always easy to predict.

Investors often wish this would be different, so they could avoid the stress of watching stocks they hold drop by 20 per cent. But markets that go down have a way of eventually going back up – just like times of exuberance have a way of moderating.

While there’s no technique to completely eliminate uncertainty from investing in inherently volatile markets, there are two rules that anyone who wishes to start investing in stocks needs to know:

Successful investing means setting your objectives and ensuring, by studying financial market history, that your expectations are realistic.
To be clear, “market history” is not just the past five or ten years.

•  If you get into investing following a period of deflation, crisis or particularly high returns, the past five years’ returns won’t give you any real insight into what returns to expect over the coming five or ten years.

Another – extremely crucial – part of your self-knowledge will be figuring out how much money you can afford to lose and how you’ll react when your portfolio declines by 15 or 20 per cent.

After you have a sense of what you hope to accomplish and an honest assessment of how much risk you believe you can tolerate, you’ll need to figure out:

• What advantages you have over the many experts working the markets.
• How you want to make money for yourself.

This part is easier than you’d expect.

• Most investors have bad plans and execute them poorly. They trade excessively, refuse to recognize and eliminate mistakes, and they risk too much capital on a particular bet.

If you can come up with a long-term plan that outlines how you want to make money, and stick to it – while understanding that there will be times when the market will not reward your effort – you’ll be in a good position to ride the ups and downs of the stock market.

If you stick to these two guiding principles, your investing strategy will take your level of risk and financial hopes into account, and be based on quality investments that can help keep you grounded.

Smart Tip provided by The Financial Pipeline. Founded in 1996 by a group of portfolio managers, The Financial Pipeline is dedicated to providing financial knowledge and education to anyone and everyone with even a passing interest in finance. Our motto, “Financial Information For the Rest of Us,” speaks for itself.