Five fundamental laws of investment


Five fundamental laws of investment

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Every successful investor needs to follow a set of rules. These rules assure the soundness of the investment and success of the investor.

Here, we present the five fundamental laws of investment which should be followed strictly in every investment and in every field. Breaking any one of the laws can result in serious losses. Obviously, there can be exceptions where the investor acts against one or two of these laws and makes a return. But still, they are the exception.

It is very dangerous and unproductive to consider yourself as an exception and consciously act against the laws of investment. You have to follow the laws to ensure your return since there's a high chance that you break at least one of these laws accidentally during the decision making and planning. Breaking the laws consciously is like considering gambling as a form of investment. Of course, there have been people who have made a profit by gambling. You, also, can theoretically make some money by gambling but the chances are very low. If you consider yourself to be the exception and put all your money in gambling, you may very well lose all of it while trying to prove yourself right. The same can happen while investing. If you break the rules intentionally, you are most likely gambling rather than investment.

The following are the five fundamental laws of investment which have somewhat broad terms, include many meanings and can be used for almost every field of investment.

1. Know what you are getting yourself into

Trying to invest your money on something you have no knowledge about is like diving into water without knowing how to swim. If you don't know what you are getting yourself into, you may drown or drift to unknown places by the waves.

You have to have adequate knowledge about whatever you are about to invest on, in any field. You don't need to know everything and you don't need to be right about everything. You only need to be right about a few things and let those few things work for you.

Of course, it doesn't mean to ignore the things you don't know completely. If you are interested, you can learn about anything to a point where you can invest in it, something that we encourage in Constant Rich. However, you can start to invest only AFTER you have an abundance of knowledge not before.

The first common mistake that investors do in this regard is to follow the masses. Only because many people invest in something, it doesn't make it profitable or even rational. The second common mistake is to be tempted when an interesting opportunity is found while having no idea about the subject. If you tell me that the shares of a mining company are now being traded at an unbelievable discount rate, I have to ignore the opportunity because I know nothing about a mining company and its operations.

2. Make an actual investment

Very often, people fail in their investment because they are actually not investing. This error has two main cause.

The first and most common is the misconception about investing itself. We invest to make a profit. Anything that in nature will not result in a measurable profit, is not an investment.

I often hear salesmen or reviewers encouraging their audiences to invest in a good quality product which lasts them a long time or is very essential, very commonly accessories or makeup tools. Although it is a good thing to buy a product with a good quality, it is not an investment. To avoid this mistake, one should be able to distinguish between an asset and liability clearly.

The second cause is the violation of the first law. People often try to make money out of something they know nothing about, leading them to make choices which may sound like an investment but in reality are not.

3. Don't lose money

Well, it seems to be very obvious, but it is actually often ignored by the investors. Of course, nobody wants to lose money but the choices they make say otherwise.

Even the most successful investors lose money from time to time. There is nothing wrong or shameful when the things don't go according to your plan but your plan should not be flawed from the beginning.

There are three things that you can do to minimize the chances of losing money. First, you need to do your homework. According to the first law, you have to have a thorough knowledge about the field and you have to use it to analyze the situation from any aspect. Don't just rely on other people's opinion.

Second, you have to assess the risks. Although I am not much for super safe investments since their return often cannot keep up even with the inflation but I am also against a very high risk. It is better to have a 10% return on a 5% risk rather than 100% return on a 50% risk.

Third, you have to have an exit strategy. Lack of such strategy is necessary because even the best plans may fail to produce a result. So you have to have a plan on when to exit the investment and when and how to cut the losses. If you invest in something without any exit plan, you might very well violate the second law. It is very evident in people who buy a home and consider at as an investment. Since you don't have any plan to sell it, among many other reasons, you cannot consider it as an investment.

4. Have a goal and a style

As an investor, you need to have a goal. Having a goal in investing is as crucial as in any other activities. You have to know what you want to achieve by investing. Are you looking to prepare for your retirement or your children's education? Are you looking for increasing your monthly budget? Would you like to have your returns on your cash flow or your balance sheet? You may have many different reasons which I cannot even think of, but regardless, you need to have a goal.

After you determine your goal, you have to choose your field according to the first three laws and pick your style of investing which gives a sense of purpose and direction to your actions.

5. Be rational

Any decision you make has to be in alignment with the first four laws. If a decision breaks even one of the four rules, you have to reconsider. However, following these laws are only possible if you are rational.

We are all emotional and these emotions affect our decisions as well. Through the eyes of our emotions, we can justify almost every decision and consider them to be in alignment with the first four laws. However, the same decisions may contradict one or two laws when observed from a rational point of view.

For example, one might prefer the stocks of his company over the stocks of its rivals. However, the favorite company may be in a bad economic shape, hence breaking the second law or it may not match the goals of the investor, therefore breaking the fourth law.

So, at the end of the process, you have to ask yourself whether you have been rational or have been thinking out of emotions.