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An Amateur’s Guide to Investing Discipline
Posted By Guest Contributor On 04/20/2007 @ 9:19 am In Investing,Personal Finance | 6 Comments
My name is Phil and I’m a guest poster here at Blueprint for Financial Prosperity (thanks, jim!). My family and I live in the great State of Georgia (US). I’m a technologist by trade and hobby, and I also enjoy dabbling with finance, politics, theology, and anything else I happen to find interesting when not enjoying the family. It’s my hope that the views I express will be practical and beneficial to you. If you feel the need to opine in my specific direction, I can be reached at phil dot the dot blogger at gmail dot com.
There are conversations all over the blogosphere and in everyday life concerning investing. You know you’ve got to sock away some money and never touch it until retirement. But does anyone anywhere say much about how to not lose money while managing a portfolio? My intent for this post is to give you some pointers on how to invest as opposed to what is a good investment, to help you lay a foundation to make better choices in the future.
It Takes Money to Make Money, So Don’t Lose It!
Rule number one of any kind of investment strategy really is “don’t lose money.” In reality, what this means is that it’s far better to take numerous small losses than one huge loss. How do you do this? Make sure that whatever individual investment you own — be it a stock, exchange-traded fund, mutual fund, bond, etc. — has a “stop loss” of, say, no more than 25%.
What is a “stop loss?” It is an investment term that means, “once the market price for this security drops below the threshold of x % of what I bought it for, I must sell.” For instance: you buy shares of Microsoft for $30 and the price drops to $22.50 (25% of $30), you sell. There is an interesting investing concept that goes along with the “stop loss” discipline, and that is the “trailing stop.” This is a cool strategy that’s very easy to establish with your broker. The gist is that if your Microsoft stock goes from $30 to $50, your “stop loss” is then adjusted upwards to maintain, say, a 25% stop at the new market price. Then, if MSFT goes from $50 to $37.50, your new stop loss takes effect and you’ve theoretically turned a profit while protecting your down-side.
The important things to remember here are establishing a percentage range that is comfortable for your situation and then stick to it. This is one part of investing that will help you sleep better at night!
Don’t Put All Your Eggs in One Basket
The other part of investing is knowing how much of your portfolio to put in one security. Let’s say you have $10,000 to invest. A common rule of thumb is to put no more than 5% of the total portfolio value into a single security/idea. So, 5% of $10,000 is $500. This may not seem like a lot of money, but the idea is to shore up the other part of the “don’t lose money” equation. If you were to lose 10% of the value of XYZ corporation from your $500 investment, you’re not going to be nearly as hog-tied as you would have been if you put half of your savings there.
Again, the point here is to be disciplined about keeping tabs on how much you’re investing in one investment idea.
OK, So When Do I Sell?
That is the $64 question, isn’t it? Personally, I’m a long-term investor and not a short-term day-trader, so I’d prefer to keep my investments going for the long haul and only sell if the market takes a big dip. When using trailing stops with a stop loss strategy, I can continue upwards with my investment and I have reasonable loss insurance on the downside. This strategy also takes all the emotion out of my investment decisions so that I am less susceptible to make a sudden move with something I own.
With few exceptions, I’m a big believer in ETFs (exchange-traded funds), because they’re just like mutual funds except they cost less and trade like stocks. Here are a few sites that have helped me develop a long-term investment strategy:
Disclaimer: I, too, am an amateur investor and offer the above post for educational purposes only. Nothing is to be construed as a proposal for the sale of investments of any type. Only you can determine the risks that your individual situation can sustain.
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