Having a simple set of investment rules could prove to be highly valuable, given the uncertain outlook for the stock market. Economies across the world are set to experience sharp declines in GDP growth and a rise in unemployment figures due to the lockdowns put in place to contain coronavirus.
By investing in companies you understand, buying them at a discount to their intrinsic value and ignoring market noise, you could capitalise on the current uncertain outlook for the stock market.
Investing in what you know
It is impossible to have a sound understanding of every sector and industry within the stock market. As such, it makes sense to focus your capital on those areas where you have a solid foundation of knowledge. It may mean that you find it easier to spot investment opportunities that go on to deliver high returns in the long run.
Similarly, it may mean that you avoid unnecessary risks. Someone without a good understanding of a sector may miss an obvious threat to its future, while an investor who has knowledge of the industry may be able to avoid common mistakes.
While it takes time to acquire knowledge about companies and the sectors within which they operate, only investing in what you understand can improve your risk/reward ratio. If you have limited knowledge, it may be a good idea to only invest in a small number of sectors and use tracker funds to obtain diversification with the rest of your capital until such a time that you have sufficient knowledge to invest directly in a range of businesses.
A margin of safety
Another investment rule that could improve your returns is obtaining a margin of safety when purchasing a stock. This essentially means that you value a company, and seek to buy it at a discount to that price. This strategy provides risk reduction, since there is a margin of safety in case unforeseen events occur or your analysis has missed relevant issues that impact negatively on a stock’s price.
At the present time, many stocks trade on wide margins of safety. As such, there appear to be numerous opportunities to obtain a large discount to a company’s intrinsic value across the stock market.
Market ‘noise’
Market ‘noise’ is the views and opinions of other investors that could influence your investment-making decisions. Ignoring them can be difficult, but also beneficial to your overall returns in the long run.
Many investors become overly emotional during boom and bust periods. This can affect their decision-making ability, and following their views can likewise be detrimental to your portfolio’s performance.
Therefore, having an investment rule that ignores the views of your peers and instead focuses on facts and figures when deciding which companies to purchase could be a means of strengthening your portfolio’s long-term outlook.
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Motley Fool contributor Peter Stephens has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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