How do the best investors in the world make such high returns? If the likes of Ray Dalio, billionaire hedge fund manager, are to be believed, it’s the result of acting on a series of principles from which one never deviates. But although Dalio’s advice is sound, it’s not the case that sticking to your guns is the only thing that you need to do to make a lot of money: you’ve got to have the right skills too.
Most retail investors don’t invest in their own investing ability before going into the market. Most rely on their intuition and hope that the companies that they buy go up in value. But the stock market is a complicated place, most profit opportunities are competed away quickly, and things can get volatile when the Fed starts playing with interest rates. In short, retail investors lose money.
How much do they lose? If you believe the statistics, it’s a lot. Nine out of ten retails investors fail to make any money on the stock market at all, with just a handful of insightful or lucky people getting the returns they want.
Although there are many reasons why this happens, one of the biggest is that regular mom and pop investors don’t develop the skills they need to compete alongside the professionals. The stock market is a highly competitive place, with companies using sophisticated analysts and even artificial intelligence to try and gain an edge. Everyone is looking for alpha – the difference between the market rate of return and the portfolio rate of return – and by definition, not everyone can get it.
Regular, small-scale investors start losing money when the market gets choppy. They see a drop in the price of a company, and they immediately lose confidence and start selling. Soon after, that same company rallies and they then rebuy it at the higher price, losing money once more. Hedge funds and others don’t often fall prey to the same mistakes because they have a background of skills and knowledge about how the investment landscape works. Here are the skills you need as a retail investor.
Knowledge Of The Fundamentals
When investors talk about “the fundamentals,” they’re talking about the things that matter to the performance of a firm or the stock market in general. Fundamentals might include things like the state of consumer confidence, the overall productivity of the economy, whether the economy is growing or not, or if there are particular profit opportunities in an industry. Investors keep track of fundamentals because they can be an indication of whether a company can make big profits over the long term. The greater the future expected profits, the higher the dividends and the greater the share price.
Knowing about fundamentals isn’t as easy as it sounds. In fact, many investors lose out when they don’t understand things like the relation of the bond market, the stock market, and interest rates. Understanding how these different economic variables affect one another is key to predicting where the stock market might go in the long term, and where your investment capital should be allocated.
Understanding Of Data
Many retail investors don’t understand data all that well. A lot of the time, they’ll just plow their money into a company they like, without really considering whether it’s the right choice from a statistical or analytical point of view.
Smart investors try to create a diversified portfolio. Diversification, a root, means choosing assets that are uncorrelated with each other. When one goes up, the others move in unrelated ways. The idea is that even if a shock affects one sector of the economy, it’s unlikely to influence another. For instance, an investor might invest in companies that provide essential utilities as well as those that sell discretionary items, like gadgets. In an economic downturn, people are likely to cut back on buying gadgets but not on power and water.
An online statistics degree offered by Michigan Tech goes into detail on how to manage data and apply statistical methods. Knowing how to work with datasets puts you at an advantage when it comes to analyzing time series data – something that could indicate how well the stock market is likely to perform over a specified period.
The best investors in the world do a lot of research. In fact, research is how many of them spend their days. They’re looking for anything that they can which indicates that a firm’s stock is a buy.
Top investors, like Warren Buffett, find ways to get information that isn’t available to the common market. Buffett sometimes goes to the companies themselves, stands outside, and then counts the number of trucks or trains leaving the facility to check that they’re doing the business they say they are. Doing things like this gives you an advantage over the rest of the market which is mostly relying on publicly-available information. Insider trading is illegal, but simply observing a company and then making your own decisions is not.
Research is also about being able to know how to get the information that you need. Many retail investors, for instance, don’t realize that they can get information on company accounts from the companies themselves, or from investing websites that keep track of company data. Pouring over things like the balance sheet can give you an idea of whether the company is in a financially sound situation, or if future profits are under threat by mounting debt.
Accounting And Record-Keeping Skills
To really understand the financial position of a company, you need to develop your accounting skills. Companies have to report their accounts by law, but the way in which they do so can be difficult to understand for an amateur. You don’t discover all you need about a company from the profit and loss sheet. The balance sheet is also an essential tool for finding out whether a company has good equity overall. High debts on the balance sheet or only a small difference between the total assets and total liabilities is a sign that the company might soon get into trouble.
Retail investors also need to be skeptical of any company reporting a large amount of “goodwill” in the assets side of its balance sheet. Goodwill is merely a subjective measure of the value of the company’s brand were it to be sold to a bidder in the open market. It’s not something that is tangible, but it can make a big difference to the overall balance sheet. Unless you’re entirely sure of the value of a particular firm’s brand, you may want to ignore figures in the goodwill section and recalculate the balance sheet yourself.
The balance sheet can contain other warning signs that a company might not be healthy. Take current liabilities, for example. Current liabilities are those that need to be paid off with current assets, like cash, within a specific time frame, usually a year. Some companies have a good net asset position when you take all of their holdings into account (like their brand name and fixed capital), but have a weak current net asset position. A firm, for instance, might not be able to pay back creditors using cash, and this could force insolvency.
Retail investors need to know how to spot these potential hazards to make sure that they aren’t overpaying for a slice of a company’s equity. There’s no point paying extra money for a share that’s not going to offer stability or high returns.
So, do you have all the skills you need to invest successfully?