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In this newsletter, I will go over 7 crucial investment principles that every stock market investor should understand.
At the end of this newsletter, you will have a broader understanding of the stock market and will hopefully be able to apply this knowledge to improve your investment returns.
When it comes to learning about the stock market, I am a firm believer that you have to have a great foundation no matter your level of investing experience.
1. Stock Market= Pendulum
The stock market is like a pendulum that swings back and forth. When you invest in stocks, you want to buy when there is pessimism and sell when there is optimism
Many people are unsuccessful because they follow the crowd and chase investments.
It's always going to be swinging back and forth from fear to greed and it's a continual cycle that will never end.
"The stock market is like a pendulum, forever swinging between unsustainable optimism and unjustified pessimism."
– Benjamin Graham
When the stock market has fear, this will give you a great opportunity to buy low and sell high when there is tons of greed.
Most people are unsuccessful because they follow the crowd and buy stocks during moments of greed.
2. Recognize and avoid stock market bubbles
You should avoid stock market bubbles at all costs! A bubble is when the crowd goes crazy into a particular investment, and the bubble will eventually pop.
Here are a few speculative bubble examples:
So, as a general rule of thumb, if your friend who knows nothing is telling you to buy into a particular asset, run far, far away! This is a sign that the herd has moved into a particular investment.
In 2000, a company called pets.com was worth billions of dollars even though they barely were selling any pet items. They were one of the first e-commerce stocks during the dot.com bubble.
Bubbles will create a great opportunity once the bubble pops. Bitcoin soared to $18,000 in 2017 during the Bitcoin bubble.
However, it got down to as low as $3,000. If you would have purchased bitcoin at those levels, you could have sold it when it got all the way up to $64,000 in 2021.
3. Do Not Over Diversify
Warren Buffett has always been very concentrated in his investments especially at a younger age. He believes you should own a small amount of stocks and know everything about them.
For every $10,000, you should own no more than 3 stocks in my opinion.
You should be very focused on the investments that you make, and if you are a part-time investor you simply cannot focus on 20+ investments.
If you want to diversify, the best way to do this is simply buying one index fund like .
This is the approach that Warren Buffett's estate will take when he dies. However, he has always bought individual stocks since he was 12.
4. Dollar Cost Averaging
Many investors try to time the market based on their emotions and trends. However, no one knows what the market will actually do in the short term.
The best thing to do is dollar cost average which means to spread your investments out over time.
For example, if you were going to invest $12,000 into one stock, you could simply invest $1,000 on the 15th of each month for a year.
This would allow you to get the average of the market over a year.
IF you are able to invest at the complete bottom of the market, I would obviously recommend you do that. However, this is a very difficult thing to do.
5. Understand Share Price Value
When you look at a stock, you should check out the market cap not the stock price. Behind every stock there is a business that has an intrinsic value behind it.
As you become more advanced, you should have a formula for finding true value.
Basic logic would tell us that a $10 stock is cheap compared to a $1,000 stock.
This is false, and it all comes down to the amount of outstanding shares.
Apple stock is worth $175 and Chipotle stock is worth $1,706.
However, Apple is worth 2.3 Trillion while Chipotle is worth $47 Billion.
Market capitalization = Outstanding shares * Share price.
The formula above will tell you what the market is giving as a value for a particular company. Some are worth millions, some are worth billions, some are worth hundreds of billions. Very few companies are actually trillion dollar market cap companies.
6. Understand Tax Advantages
There is a significant tax advantage associated with being a long term investor versus a short term trader. To begin, short term capital gains (1 to 365 days) are taxed as ordinary income, the highest rate.
On the other hand, long term capital gains (366 days or more) are taxed at a lower rate, saving you as much as 20% depending on what tax bracket you fall into.
On top of that, Dividend income is taxed at only 15%.
You can read more about capital gains and tax rates on the IRS website, and then apply it to your income tax bracket situation.
7. Ignore The Noise
Noise is everywhere when it comes to the stock market.
If you always are keeping up with the latest drama, you will eventually end up making horrible investment decisions.
When investing in stocks, you need to make emotionless decisions.
My best piece of advice to you, therefore, is to turn off the talking heads! Formulate your own well researched opinions and sleep easy at night. Don't let noise impact your investing decisions.
I would check on my stocks once a week, maybe twice depending on my investments.
I would also keep track of the major company announcements, quarterly earnings reports, and annual reports. Beyond that, the rest is just noise.
In summary, understanding and following these 7 investment principles will help your investment portfolio grow consistently over the long-run.
These simple investment principles alone, as obvious as some may be, are frequently overlooked and/or ignored by many investors, largely due to a lack of knowledge and emotional investment decision.
I hope everyone has a great rest of the week!
If you have any questions, feedback, or just wanna say hey, email me at firstname.lastname@example.org
Stay Hungry, Stay Long