10 great investing rules from history

10 great investing rules from history

 

Remember that old adage to the effect that those who don't learn lessons from history are bound suffer avoidable hardship?

Learning the important lessons that history of investment offers, will rev up your investing profits. . .

1. Put all your eggs in one basket and watch that basket!

This saying comes from Mark Twain, but has been applied to stock market investment more or less verbatim by both John Maynard Keynes and Warren Buffett. Modern portfolio theory suggests that one can reduce risk by diversification.

However, if you were an active investor you would do better to concentrate your shareholdings in a limited number of companies which you feel you understand. This can actually reduce risk.

2. When the ducks quack, feed them

This is an old Wall Street adage relating to initial public offerings. Investment bankers are out to make money and will sell the public anything within the bounds of the law.

Research suggests that, in general, IPOs rocket upwards on the first day's trading but tend to under perform comparable companies over a three-year period. Since small investors don't receive fair allocations of the best IPOs but are landed with the duds, they should avoid the new issue market entirely.

3. Markets make opinions, not the other way round

When markets rise, commentators find a way of rationalising the gains. Take the tech bull market. We were told that the 'valuation clocks' were broken and that companies deserved to trade on a higher price-earnings ratio.

We were also told that US productivity had risen and that the US would experience a higher growth rate in the past. We were also told that Greenspan et al would prevent another cyclical downturn. All these comments were spurious rationalisations of an 'irrationally exuberant' market.

4. Buy low, sell high

This advice seems obvious, but investors always ignore it. The demand curve for investment assets is like that for a luxury good -- the higher the price, the greater the demand.

Hence we see turnover rising during a bull market and falling during a bear market. Investors should always be prepared to act contrary to the market.

5. When the rest of the world is mad, we must imitate them in some measure

This observation came from the mouth of an eighteenth-century banker, John Martin, during the South Sea Bubble of 1720. It is another expression of the 'greater fool' theory, namely that you can buy over-priced shares and sell them on at a profit to some sucker.

This speculative attitude has been much in evidence in recent years in the form of momentum investing. Of course, you can make money if you find a greater fool, but you also will lose your money if you don't.

6. During a bull market nobody needs a broker. During a bear market nobody wants one

This is another Wall Street saying, cited more recently by Alan Abelson in Barron's. We are now more aware than ever that most brokerage research is generally of a low quality and that broker recommendations cannot be followed profitably.

Investors should avoid reading research by brokers whose parent company provides financial services for the company concerned.

7. Every man his own broker

This is, in fact, the title of the first investment book, written by Thomas Mortimer in the 1750s. It was republished several times. If you can't trust brokers, you must replace them. The problem is that the private investor is not well-equipped to do so. So, first learn, then invest.

8. Markets can remain irrational longer than you can remain solvent

This saying comes from John Maynard Keynes, the great English economist. He was also an acute observer of markets and a speculator. The point of Keynes's comment is that your observation may be fundamentally correct but it can take the market a long time to catch up.

For example, the dotcom bubble ran for almost five years from the flotation of Netscape in the summer of 1995 to the Nasdaq collapse in March 2000. Many people lost a lot of money shorting the likes of eToys and Amazon.com before the market woke up to its absurd overvaluation of the sector.

9. A mine is a hole in the ground with a liar standing over it

This saying also comes from Mark Twain. It should remind investors to be wary of all projectors, whether they are promoting gold mines, biotech or some other new-fangled technology.

In general, the promise of outsize profits are followed by the reality of painful losses. You will make more money in the long run by restraining your greed.

10. Be diffident when others exalt, and with a secret joy buy when others think it in their interests to sell

This advice comes from the English writer, Sir Richard Steele, in an article for The Spectator in the early 1700s. To my knowledge it is the first expression of a contrarian investment philosophy.

The art of investment lies in judiciously going against the crowd. It is both intellectually more fulfilling to refute the market consensus and in the long run should be more profitable. Academic research suggests that unloved 'value shares' tend to outperform so-called 'growth stocks' over the long run.