10 great investing rules from history

[sunilpal]

10 great investing rules from history

December 16, 2008

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.

[sunilpal]

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.



Image: The Wall Street Bull. | Photograph: Rediff.com

[sunilpal]

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.

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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.



Image: A Diwali message on the Nasdaq Stock Market tower at Times Square in New York. | Photograph: Rob Tannenbaum, Nasdaq

[sunilpal]

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.