Being able to grow your life's savings through investment is important. Over the past century, the US stock market has offered the greatest returns, outperforming the housing market and other types of financial securities. These are some important tips for every investor.

1. The Investing Triangle

Investing is a triangle formed by three axes: (i) return, (II) risk, and (iii) time.

Whenever you push one of the three axes, the other two will expand. This means that in any investment:

• If you wish to have high returns, the risk becomes higher and the timeframe needed to achieve these returns becomes larger
• If you wish to have high returns in a short period, you will have to deal with huge risks
• Never trust someone promising high returns and low risk in short time frames

2. The Relation between Return, Risk, and Time

When you invest, don’t entirely focus on returns, mind the risk, and calculate the timeframe.

• Balance all your investing decisions between Return, Risk, and Time, and you will be rewarded
• If you ignore the time you will probably get bored, while if you ignore the risk you will probably get bankrupt

► Two Categories and Ten Sources of Risk at TradingCenter.org

3. Portfolio Diversification -The Golden Rule of Investing

There is only one rule in investment that can be mathematically proved true. This rule is portfolio diversification.

• Don’t put all your eggs (money) in the same basket (position)
• Historical research has shown that portfolios applying wide diversification techniques perform much better than portfolios containing a few financial assets
• Institutional investors apply more diversification techniques than you can even imagine, and rarely allocate more than 2% of their capital in any individual position
• Differentiate your portfolio in different asset classes, industries, currencies, and even economic zones

Macroeconomy:

4. The Risk-Free Rate of the Economy

Theoretically, there is only one risk-free rate in the economy, the annual yield of the government bonds. Therefore, whatever return exceeds that rate, it is (by definition) incorporating some forms of risks.

• When you are promised high returns, sooner or later, you will have to deal with high risks (100% certain)

5. The Basic Macroeconomic Cycle

Before making any investment, make sure you have identified the current phase of the economic cycle. Usually, central banks are implementing monetary policies toward a 7-9 year economic cycle. The main weapon in their arsenal is adjusting the level of interest rates. The level of interest rates defines the level of liquidity in the market, and therefore, consumer spending and consumption.

• The current stage of the economic cycle determines the level of liquidity in the market
• The perfect time for investing is when each economic cycle begins and the worst time is when each cycle is about to end
• Generally, high inflation leads to higher interest rates (bad for investment) and high unemployment leads to lower interest rates (good for investment)

When it comes to Businesses:

6. Cash Flows are more Important than Earnings

The ability of any business to generate profits is important, however, what matters the most is the ability of that business to generate positive cash flows. Larger inflows than outflows will determine, to a very high extent, the success of any business in the long run.

• Most businesses fail due to weak cash flows, not due to weak earnings
• Always focus on EBITDA {Earnings Before Interest, Taxes, Depreciation, and Amortization}
• In the case of a new and very promising company, this company may suffer from negative cash flows for many years, so make sure the management is capable of ensuring enough funding from external sources

7. Corporate Strategy is the King

Cash flows and earnings are important, but what is more important is business strategy. Corporate strategy is everything. If the strategic position of a company is expected to be weak in the future, this company will probably fail long before.

There are three main corporate strategic advantages:

(i) Quality Premium (a company that sells better products than its competition)

(ii) Cost Leadership (a company that sells at a lower price than its competition)

(iii) Limited Resources (a company that possesses a patent, a contract, or any other tangible/intangible asset that the competition can't have)

If a company doesn’t possess one of the above three strategic advantages, it will face trouble in the future.

8) The Quality of Management

When you are about to invest in stocks, hedge funds, venture capitals, or ETFs, two things matter the most:

(i) the past performance, and

(ii) the quality of management

• Give extra weight to the quality of the management

9) Evaluate your Investments with Flexibility

Don’t use the same rules and metrics to evaluate different investment opportunities, wise investors are very flexible.

• The accepted P/E of a static company should be considerably lower than the P/E of a dynamic company
• Prefer to use the P/E/G ratio (Price/Earnings/Growth) for dynamic industries than the classic P/E
• Use the Price-to-Book (P/B) ratio only for financial companies

10) The Dividend matters a lot

When it comes to investing, dividend matters a lot. If you hold a company that is paying you a 4% annual dividend, in 10 years you get half your money back.

• A good dividend means almost certain future returns (this is important in a world of uncertainty)
• High-dividend stocks are significantly less vulnerable during bear markets
• Always include some high-dividend stocks in your portfolio, a minimum of 20-25% of your portfolio's value

 

◘ Investing Tips & Advice

George Protonotarios, Financial Analyst

for TradingCenter.org (c)