1. Never Borrow Money to Invest
One of the greatest economists in history once remarked, “Markets can remain irrational longer than you can remain solvent.” Take the recent case of the most royal of blue chips, General Electric and Berkshire Hathaway. Within the past year, GE has fallen from roughly $40 per share to as low as $5.87 per share and the dividends slashed from $1.24 per share to $0.40 per share. Even if you had waited until the stock fell the first 50% to $20 per share, and borrowed against your stocks, you would have long been hit by a margin call requiring you to come up with more money to avoid your broker liquidating your position. Berkshire Hathaway, likewise, has seen its Class A shares fall from $150,000 to roughly $72,000 and it Class B shares falling from $5,000 to $2,150 per share.In both cases, you are dealing with a company that would appear to have a better than average probability of trading at substantially higher prices five years from now. Yet, if you had borrowed money, you would have been forced to sell out long before the stocks began to rise. To add insult to injury, not only would have been correct, you would have suffered the pain of losing large amounts of money because your timing was not perfect.
For more information on the subject, read Margin 101 – The Dangers of Speculating with Borrowed Money.
2. Don’t Invest Funds You Need for the Next 5 Years
As Warren Buffett pointed out in his most recent shareholder letter, the market was up 75% of the time during the past century. Trying to figure out the specific years those gains would happen is a fool’s game. If you want to buy a house, prepare for retirement, send yourself or your children to school, or expect to have large medical bills over the next five years, stocks are not an appropriate place for you to invest your money. In the long-run, they have proven to be the surest path to wealth for those who are disciplined and rational. In the short-run, they can experience nauseating volatility, fluctuating like a roller coaster.
3. Once You Have Developed a Plan, Don’t Check Stocks Daily
Have you put together a plan that works? Do you dollar cost average, reinvest your dividends, max out your 401(k), and contribute to a Traditional IRA or Roth IRA? Are your investments low cost and diversified like an index fund? If that’s the case, you simply need to follow the same instructions that appear on most shampoo bottles: Wash. Rinse. Repeat.Over several decades, a program such as this has proven to be hugely successful, resulting in millions of dollars in wealth for those who follow it. If you have the patience, will power, and discipline to engage in such an investing plan, why make yourself sick by looking at stock prices daily? Just as a sale at the grocery store allows you to buy everything from cereal and milk cheaper, a drop in stock prices allows you to get more equity (ownership) in companies. When things recover, that means you have a right to even more earnings and dividends.
4. Don’t Rely on One Salary or Source of Income
A big danger to your investments is the risk that you will find yourself unable to pay your day-to-day bills and forced to sell assets to fund your living expenses. The most sensible way to avoid this is to follow the Berkshire Hathaway Model, which calls for multiple sources of income that are non-correlated. In other words, your income isn’t diversified if both you and your spouse work at the same factory or in the same industry. If you are a realtor and own rental properties, you are less diversified in your income sources than a dentist who owns rental properties.
