The following 6 principles come from the Rule #1 tradition. In 2014 the non-profit group, The American Association of Individual Investors rated the Rule #1 hedge fund strategy the #1 hedge fund strategy last year. Our hedge fund produced 50% returns last year.
The best investors in the world use these 6 principles . . .
They are awesome.
They have been around since the 1930’s and they are still practiced today by the best investors in the world. Investors like Warren Buffett, Charlie Munger, David Einhorn, Monish Pabrai and myself all use these 6 principles, and we all get great returns.
Rule #1 states “Don’t lose money,” and these 6 principles are always on my mind to help me avoid violating that critical rule.
This is easier said than done when you are investing real money. Money you can’t afford to lose tends to be ‘hot’ or emotional. Pro gamblers try to avoid sitting down with more than they can lose but anyone investing all of their own hard-earned money is always sitting down with more than they can lose. Fear of losing more than you can afford to lose tends to make the mind go irrational. You start guessing.
You can’t tell the difference between a good idea and a bad idea. Investing decisions are not life and death decisions but still, remaining rational in the face of intense emotions is an art that is learned in the trenches.
2) Understand The Business
Understand what you’re buying. Stick with what you know and realize what you don’t know.
Focus your attention on industries that you’re already comfortable with. Imagine that you were going to have to own and operate a business. Can you do that in an industry where you’re seriously thinking of making an investment?
You need to be able to understand the business if you want to buy it.
3) Love What You Own
Love what you own. Put your money where your values are. Most of us have the intention to make the world a better place, but seem to forget that the businesses that they invest in have a direct impact on what is going to exist in the world in 20 years.
85% of all of the money in the stock market is “little guy” money. This is money from our 401K’s our retirement plans and our pension plans.
Vote for the future that you want to see, by investing your own money into businesses that you want to see 20 years from now.
Investing in companies that you love transforms it from a chore or obligation into something that you are passionate about, something that is fun.
4) Wait for an Event
Wait for an event. When you boil it down, we buy fear and we sell greed. Fear creates a lot of selling action.
When stock prices are set by the most fearful or the most greedy investors, those who are fully in the sway of emotion, it’s clear that the market prices are often far from rational. The big players in the market – mutual fund managers, pension fund managers, insurance fund managers and bank fund managers – are not the most cold-blooded rational creatures on the planet.
When the market begins to go down these greedy investors get out quickly to avoid losses. If the company is wonderful, and you understand it, that’s when you take advantage.
5) Reduce Your Basis
Your basis is the amount of money that you have on the table. All reduce basis means is getting your money off of the table.
This is the unsung hero of the Rule #1 saga: If you can lower your basis with return of capital.
That means cash flow strategies from:
- Really safe options trades
When you reduce basis your risk of losing money goes down proportionately.
You lower your risk of losing money by reducing your basis.
When my basis goes to zero, where is my market risk? If I start spending the money to live on instead of reinvesting it, then the basis stays the same but the return still goes up because you’re getting dividends every year.
In essence, I’ve created for my retirement a kind of special bond – one that is backed by one of the best companies in the world and yet pays out based on an ever increasing coupon rate, one that within ten years is over 20% a year and rising.
6) Create a story
Create a story for the company you want to invest by combining all the previous principles into a cohesive idea about why this is a great company. Then once you have that story, invert it by flipping to the opposite point of view. You should try to create the argument that this investment is a dumb idea and if you can’t, then that is assign that you don’t know enough about the company yet.
Ready to Start Picking Rule #1 Approved Stocks?
Now that you fully understand the process for researching wonderful companies, make sure you download my Free Stock Picking Guide that covers which companies you should even be researching in the first place, all of these research principles in greater detail, and how to evaluate the financial mertic of a company to buy at the right price.
Phil Town is an investment advisor, hedge fund manager, 3x NY Times Best-Selling Author, ex-Grand Canyon river guide, and former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo, and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence.