The stock market is often seen as a gamble – a playground for the wealthy, where fortunes are won and lost overnight.
But unlike gambling, it’s possible to consistently win at the “game” of investing… as long as you play by the rules.
These rules make investing in shares simple, much less risky, and make your returns somewhat predictable.
If you want to invest in shares successfully, here are the rules you must play by.
“Investing is a unique kind of casino — one where you cannot lose in the end, so long as you play only by the rules that put the odds squarely in your favour.”
Benjamin Graham, The Intelligent Investor
Rule 1: Don’t Pick Individual Shares
When you buy a share, you’re buying into the ownership of a business.
Although your investment may be tiny, you still have a stake in a real business.
To intelligently invest in an individual company’s shares, you would need to know the underlying business.
You’d have to be aware of its strengths and weaknesses, opportunities and challenges, and any competitive advantages it holds.
And as you aren’t running the business yourself, you also need to know and have faith in the management team to operate the business efficiently and honestly.
As most people have no interest in reading annual reports and balance sheets, understanding the strategic takeover plans of management, or comparing the operating margins and debt levels of company X vs Y, they shouldn’t invest in individual shares.
Buying shares without analysing the fundamentals of a business isn’t investing; it’s speculating.
The smarter alternative to speculation is buying low-cost index funds.
The Benefits Of Index Funds
Index funds provide instant diversification among the hundreds of businesses held in the index.
If you buy into a S&P 500 index fund, you’re investing in the 500 biggest companies in the US.
If any company collapses or performs poorly, there will be another company ready to replace it.
You can’t lose money investing in index funds over the long-term unless capitalism fails – and if you’re banking on that, you’re better off using your money to build a bunker and stocking up on non-perishables.
The downside to index funds is that you will “only” achieve the long-term average return of the stock market (7%-10% per year).
But most investors who try to pick winning stocks fail to beat the index consistently anyway.
Rule 2: Invest Regularly And Automatically
“Time in the market beats timing the market.”
If you’ve never heard that little nugget of investing wisdom before, it teaches a fundamental lesson: timing the market is (almost) impossible.
Financial analysts whose full-time job is to correctly call which way the market will move regularly get it wrong.
Instead of waiting for the perfect time to invest, the average investor is better off ignoring what the market is doing altogether and regularly investing in their pension and ISA no matter what.
By doing so, they’ll benefit from pound cost averaging – when the market is low, their regular contribution will buy more units.
When the market is rising, they’ll benefit from the rise in value of the shares they already own.
So, set up a standing order to automatically invest in index finds every payday, and keep investing no matter what.
Rule 3: Invest For The Long Term
The more you invest and the longer you leave your money in the market, the greater your return is going to be.
Any money you put into the stock market should be invested for at least five years. Ideally, you’d want to leave it untouched for decades.
Although there are spikes and falls, the long-term trend of the stock market is up.
Having a long investing time horizon reduces the risk of losing money by selling during a crash.
You’ll also benefit from the snowballing effect of compound interest (earning interest on interest), which will lead to unimaginable wealth over decades of investing.
Rule 4: Ignore The Market
To help investors understand the wild, unpredictable swings of the stock market, Benjamin Graham introduced us to Mr Market in his book, Intelligent Investor.
Mr Market is erratic, highly irrational, and completely unstable – in other words, a basket case.
Every day, he comes to tell you the value of your shares, which would be useful – if it weren’t for his wild mood swings.
When he’s having a good day, he overstates their value; and when he’s feeling down, he tries to convince you they are worthless.
Mr Market represents the wider sentiment of investors in the share market.
Sentiment in the economy and global markets can cause the stock market to rocket to unjustified heights or plummet to the-worlds-ending-for-sure-this-time lows.
Just like you would ignore your crazy friend Mr Market, you should ignore the short-term instabilities of the stock market.
The daily fluctuations and even the once-every-10-years-or-so crashes are going to have no effect on your wealth if you’re investing for the long-term.
Wrapping It Up
It doesn’t take big brains or deep pockets to invest in shares successfully.
The more you try to over-complicate it, the more likely you are to lose money.
Regularly investing in low-cost index funds, is the key to building substantial wealth over the long term.