“Sharing this excerpt from chapter 2 of the book Secrets of Millionaire Investors by Adam Khoo“
Very often what sets average and successful investors apart is their psychology or their way of thinking. Although all master investors use very different strategies and investment tools that may even contradict each other, they all share the similar psychological makeup that makes them successful.
Here are seven of the most powerful success habits of successful investors.
1. Buy On Strict Rules & Not Emotions
All successful investors have developed a time-tested and proven system for selecting, buying and selling investments in a way that makes them money consistently. They always buy and sell securities based strictly on a set of clearly defined rules or investment criteria. For example,Warren Buffett will only buy a company if it has shown consistent earnings growth over five years, has little debt, has a high return on equity, has a strong management team and is selling at a price that is way below the company’s intrinsic value. If a stock does not meet every single criterion, he does not buy!
Successful investors never allow their decisions to be swayed by their emotions or by the advice of other people. For example, many successful investors have a rule for selling their investments and cutting their losses once their investments fall 10%-20% below their purchase price.The moment this happens, they sell without thinking twice.They never let fear, pride or ego get in the way.
On the other hand, most average investors (who keep losing money) do not have a system for investing. They buy and sell based on the opinions and advice from their friends or relatives (who are usually broke too).Their decisions are usually driven by the emotions of fear and greed, instead of a set of well-defined criteria. For example, when they see a stock rallying like there is no tomorrow, their greed for quick profits and their fear of losing out drives them into buying, even if the stock may have lousy earnings or may have broken other rationale buying criteria. Sure enough, the stock come tumbling down the moment they make their purchase, causing them to lose their hard earned money.
And when the stock’s price falls 10%-20% below their purchase price, they do not follow smart selling rules and cut their losses early. Instead, their ego and pride gets in the way.Their fear of making a loss makes them hold on to their losing position. They say to themselves ‘it will come back again’ or ‘it cannot go down any lower’. Sure enough, the stock sinks lower and lower until they are forced to sell at a massive loss.
2. Admit Your Mistakes Early.
Successful investors know that no matter how great their investment strategy is, it is never hundred percent accurate. They know that no matter how smart or experienced they are, they too make mistakes.
The difference between successful investors and average investors is that the former admit their mistakes early. Once successful investors know they have made a wrong investment decision (the stock price moves against them), they will sell and minimize their losses immediately. On the other hand, most average investors hate to admit that they made a bad decision.They will start giving excuses and hold on to their bad investments in dissent. As a result, they make huge losses that wipe out any gains they may have made in the past.
‘It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong’
– George Soros, One of the World’s Most Respected Investors
As quoted by legendary billionaire investor George Soros, master investors know that they may be wrong from time to time. However, if they minimize their losses by admitting their mistakes early, they will still make huge profits from the gains they make from their good investments. For example, take a look at a typical profit & loss chart from an average investor.
For simplicity and easy calculation, I have standardized the cost price and quantity of all six stocks in this hypothetical portfolio. As you can see, most investors would make some good investments and some bad ones. Typically, the losses from the bad investments would wipe out all the profits made from the good investments, sometimes even resulting in a net loss (a bracket signifies a loss).
Even if a great investor gets half his stock picks wrong (which is highly unlikely), he would still make a profit if he knows how to sell his losing investments once it falls 10% below his purchase price (i.e. $45).As you can see from table 2 below, even if you were to make 3 bad stock picks out of 6, you would still make an 18.67% return by cutting your losses early. So can you imagine how successful you can be when you learn how to pick 8 out of 10 great stocks and minimize your losses on the 2 bad ones?
This is why US presidential investment advisor Bernard Baruch once said; “Even being right three or four times out of 10 should yield a person a fortune if they have the sense to cut losses quickly.”
3. Become An Expert and Don’t Rely on Experts
The third success habit of successful investors is that they only make investments in areas in which they have an expertise. Great investors make investment decisions with a high probability of success not because they are lucky or because they have a crystal ball. Their successful track record comes from the fact that they have a tremendous depth of knowledge and expertise in their area of investments.
All this comes from hours of research and study.Warren Buffett is so good at being able to pick companies that will increase in value simply because he has a very good understanding of how businesses work. He will spend hours reading the company’s annual reports and dissect every price of information before making a decision. The reason why Warren Buffett makes very few bad decisions is because he only invests within his circle of competence. He only invests in businesses which he knows and understands inside out. The reason why Buffett avoided investing in any Internet businesses during the dotcom boom of 1998-2000 is because he did not understand their business models. By so doing, he avoided one of the greatest market crashes in recent history.
‘The market, like the lord, helps those who help themselves. Unlike the lord, the market does not forgive those who know not what they do’
– Warren Buffett
On the other hand, the average investor tends to invest in stocks
& other financial securities without having a thorough understanding of what they are doing. I am usually shocked to hear that people actually buy shares in a company without doing thorough research on the stock’s financial history, growth prospects, management strategy and historical price patterns. Instead, they buy on advice from ‘other experts’ who they believe have all the right answers. Remember, that making money in any field of endeavor is never easy, whether it is in business, Internet marketing, sales or investing. If you want to be a great investor, you must be willing to spend the time to learn thoroughly and be an expert in the subject of investing!
4. When there is Nothing to Invest in, Don’t Invest
One of the main reasons why many professionally managed funds are not able to consistently beat the S&P 500 is because they are required to invest 80% of their funds into the market at any one time. If they were to hold more than 20% of their assets in cash, they will be criticized for not putting the money to work. The problem is that it is not always a good time to invest and you will not always find investments that match the investment criteria of a successful investment. By constantly having to be invest in the market; they suffer as much losses from bad investments as they do enjoy the gains from good ones. The trouble is many amateur investors make the same similar mistake and are quick to jump into the first investment that comes along.
One thing about all great investors and traders is that if they cannot find an investment that confidently meets all their criteria, they do not invest or trade. Successful investors have the patience to wait indefinitely until they find an investment with a very high probability for success and a low risk of loss. Only then do they make the confident decision of taking a large position.
5. Take 100% Responsibility for Your Results
As a successful investor, you must have the attitude of taking full responsibility for the results you have acquired, both success and failure. Lousy investors tend to give excuses and lay blames whenever they lose money. Their usual responses include: ‘my broker gave me the wrong advice’, ‘the market went against me’ or it’s just bad luck’. As a result of not admitting that they made a wrong decision, the average investor does not learn from his mistakes to become a better investor. Successful investors are the first to admit that they made the wrong decisions and used the wrong strategy. They learn from their mistakes, become wiser and move on to their next investment.
6. Be Passionate About Investing
You must know that passion is the most important ingredient for being successful in any field of endeavor. The world of investing is no different. If you do not enjoy looking at charts and studying financial data from annual reports, then you will never be a successful investor. If you are purely investing with the motivation to make a quick buck then you will probably be like the majority of people who will lose money and give up.
‘I have enjoyed the process (of investing) far more than the proceeds, though I have learned to live with those, also’
– Warren Buffett
Tiger Woods did not chose to play golf because of the money; it was because he loves the game. Celine Dion (or any other successful artiste for that matter) chose to become a singer not because of the money, but because she loves to sing. Similarly,Warren Buffett started investing in stocks not because he was motivated by materialism; it was because he loved investing. This is evident by the fact that after making US$42 billion in the markets, he still lives in a $31,500 house that he bought 30 years ago. And what did he do with most of his wealth recently? He gave it all away to charity. In fact,Warren Buffett once remarked in a speech to his shareholders,‘we should pay to have this job!’
So why is passion so important to success? Remember that to be good in anything, you have to be an expert in it! The only way you can be an expert in something (i.e. investing) is if you live, breathe, eat and sleep investing. When an investment guru listens to the weather forecast, he thinks of how it will impact oil prices and energy stocks. When he shops at the supermarkets, he notices the best selling products and the companies (stocks) that sell it! When he reads the news to find that interest rates are rising, he thinks about how it will affect bond prices and financial stocks. The only way you can be totally focused in something is if you truly have a passion for it.
7. Reduce Risks & Maximize Returns
The average investor believes that in order to make high returns from investing, he has to take big risks! The successful investor on the other hand is usually risk averse. He believes that returns are not related to risk. Instead, risk comes from not being an expert at what you are doing. The master investor will only invests if he finds an investment with a very high probability of success, one with very high potential upside with limited downside. So, only invest when with minimal risks and very high returns.
Now that you have a clear understanding about the basics of investing, let’s get this party started by diving into the first growth strategy…