8 Stock Market Rules that will make you Financially Independent
If you want to be successful at any game, the first thing you need to do is to learn the rules. Once you know the rules, you can become an expert by practicing and learning more about the game. This is also true for investing in the Stock Market.
If you want to be successful at investing, you need to know the stock market rules! If you play within the rules you can be sure that you won’t get nasty surprises down the road.
So, without much further ado. Let’s learn the stock market rules!
1 – Portfolio Diversification and Asset Allocation will protect your nest
Portfolio diversification is a fancy term for “Don’t put all your eggs in one basket”. This is common sense, but we are emotional creatures who believe in mirages, this is, sometimes you will find a stock or sector that looks incredible and is a sure thing, therefore, since you believe is a sure money making thing, you will be prone to put all of your money on that stock or sector.
There are only 2 outcomes to this approach. First outcome, you are lucky and the stock/sector was indeed a big winner and you make a lot of money from it, you give yourself a pat on the back and move along, the problem is that, is also human nature that after having a big winner, we would like to find the next big winner, and that’s exactly when we lose money.
Second outcome, the stock/sector was indeed a mirage and now your portfolio has lost 50% its value! You are now in an emotional crisis which will cause you to make even more mistakes…
So by all means, don’t go all-in for any stock, have a maximum of 10% of your portfolio on any stock! Again, I don’t care how great a stock looks, don’t bet on it!
2 – Saving money and investing will make you financially independent.
This rule is easily overlooked by most investors, although investing in the stock market is indeed the best way to grow your money, you can’t grow money if you don’t have any! This is why making a habit of saving money every month and investing it in the stock market will make you financially independent. Start by saving $50 each month and work your way until you can save at least 20% of your monthly income, it will take time so don’t get discouraged. Remember, the reward will be great!
Compound Interest AKA “The Snowball Effect” is what happens when you reinvest the money earned in the stock market. If you start with $1000, make 10%, you know have $1,100, if you make 10%, you now have $1,210. If you keep doing this for several years, adding more money to the snowball, you will have a lot of money in the long run. How much you may ask? Well, you can turn $100 into $500,000 with the power of dividend stocks.
3 – The Stock Market will crash/correct itself, deal with it.
I get it, you don’t want to lose money and just the thought of possibly having a stock market crash is so scary! I totally understand you, but guess what? Stock Market crashes and corrections are bound to happen! It’s normal, expected and part of the game
What nobody tells you is that a stock market crash or correction is the best opportunity for a smart investor. When irrationality and fear reigns in the stock market, smart investors (like you and me 😉 ) will understand the following:
A) Stock Market Crashes don’t last forever, which means, you will not sell your stocks at a loss and they will recover.
B) If possible, you will buy more stocks! Why? Well, because when your favorite stock is being hit by a stock market crash, most likely is now at a “discount price” and eventually the market will realize that and the price will go up. So, you might as well load up on cheap shares! Is almost like finding a brand new BMW at 50% the price!
And please, don’t ever try to time the market! You might think that you are super smart by sitting on the sidelines waiting for the crash to start investing. By doing that, you are missing out on the “Snowball Machine” and you are effectively decreasing the potential size of your retirement nest. I’ve been hearing that the stock market crash is coming since at least 5 years ago… I get it! Winter is coming! But I will enjoy these summer years and so should you!
If you want to learn what to do when a stock market crash is happening, I got you covered! Check this post with 5 things you have to do in a market crash
4 – Money and emotions don’t get along.
Fear is your worst enemy when it comes to investing in the stock market. Fear is designed to keep us alive: If you are in the wild and see a lion, you will get afraid, go full survival mode and run faster than Usain Bolt towards safety. I’m not asking you to be fearless, because the only fearless persons are psychopaths. Instead, all I’m asking is that you need to overcome your fear of losing money.
Stock market crash are bound to happen, remember that right? One thing is knowing that it will happen, another very different is experimenting the gut wrenching pain of seeing your portfolio drop by 35% in months. When this happens your brain will go again into full survival mode and your first reaction will be to sell your stocks to save whatever is left and stop the pain!
And if you do that, you are effectively losing more money and causing even more pain!
Instead, I need you to come to terms with the “feeling” of seeing a sudden drop in your portfolio, you need to understand that feeling, come to terms with it and move along. By doing this, when the stock market crash happens, you will know that is just a temporary thing, that eventually your stocks will go up and instead of letting fear take control and call the shots, you will be able to stay chill, walk away from your computer/smartphone, go outside an enjoy life, and patiently wait for your stocks to go up!
Fear is your worst advisor in the stock market, so if you feel angry/depressed/anxious or are just having a bad day, don’t take any decisions, logout from your broker and wait until you feel better. I only take investment decisions when the market is close, this way I avoid my emotions taking control of my decisions.
5 – Avoid High Fees and Taxes like there’s no tomorrow.
Taxes and Fees is a subject that in my opinion is not discussed enough this days. Let’s start with fees, every 1% more that you pay in fees for a mutual fund or ETF, you are effectively destroying your retirement nest. Fees are like a cancer that must be avoided at all cost. I’m my blog post “Investment Fees Matter: DIY Investing vs Financial Advisor” I demonstrated how by reducing the fees you pay to own your funds, you can effectively retire with almost 40% more in the bank after 30 years. That’s how terrible fees are!
In regards to taxes, if you are investing in a non-registered account, or if you are constantly buying and selling stocks, you will be taxed on your capital gains! And if you live in Canada or the US and are close to the higher tax bracket, you will be taxed almost 50% on those capital gains.
This means that if you sold a stock and gained 10%, you are actually making only 5% after paying taxes! This is why Investing, Buying and Holding stocks/funds for the long-run is more beneficial than trading stocks. Even if you manage to make a killing by trading; the money you have to pay to the tax man and in fees will effectively destroy your stellar performance!
6 – Index Funds are your best friend!
We all want to be great investors that always beat the market, but in reality, beating the market takes time, dedication, lots of research and a good chunk of luck. I’m not claiming that you can’t beat the market, I’m beating the market by 6 folds in 2018 ( By June 2018) and it’s not because I’m a magical stock market wizard, but because due to my research, strategy and the help of lady luck I managed to achieve that goal.
The thing is, the SP500 which is a fund that tracks the performance of the biggest 500 companies in America, is the golden standard for market performance, and several studies conclude that the best strategy for every investor is to own Index Funds, this way you capture the entire performance of the stock market! And you do this by doing nothing! You just buy the Index, sit down, relax and forget about it.
I encourage that every investor has to own Index Funds like the SP500, NASDAQ100, Emerging Markets, Global Market and REITs among others to add diversification and reduce the volatility of your investment. I personally own 20% Index Funds, the rest I have it between Growth Stocks and Dividend Stocks.
So please, if you know nothing about the stock market, buy an Index Fund BEFORE buying individual stocks!
7 – Water the flowers and remove the weeds
Yes! This simple rule will save you from a lot of headaches and will maximize your returns. Its human nature to lock-in the gains from our winner and let our losers run with the hope that one day, the losers will turn into winners. But there’s a big problem here, nobody knows if the loser will EVER turn into a winner.
Let’s do a math exercise. If you have $1000 invested in the stock ABC, and suddenly the stock drops by 50%, you now currently have $500. If you are really positive about the stock and believe that it will turn around, you might think that you need the stock to make you again 50% and you are breaking even… NOPE!!!…
If you have $500 and the stock goes up 50%, you now have $750… This means, that if you want to break even after losing 50%, your stock has to go up by 100% and for that to happen it can take several years, if not decades, and that will also erode your retirement nest.
So by all means, if your stock suddenly turned into a loser, the company is constantly losing money, the news are terrible and it’s constantly bleeding, don’t wait for it to come around, sell it!
And if you have a big winner, what are you going to do? You are going to LET IT RIDE! Yes, let that winner ride the entire wave, it might make you 10%, 30%, 100% or even 500%, but if you sell to soon, you are jumping from the train and you will be left out from any potential earnings.
8 – Having a clear plan will save you on the rainy days
Everything is fine when we are on a Bull Market, all stocks are going up and we feel like we are the next Warren Buffet in the investing world, now, when the rainy days come, the Bears take control of the market and every single stock keeps dropping to incredible new lows, the only thing that is going to keep you on track is having a plan.
What does this plan looks like? Start defining WHY are you investing, is it for retirement? To pay your kids’ education? To generate a fixed income? Once you answer this question you have to address the following:
1 – How much risk/volatility can I tolerate. In a bull market we all are aggressive investors, but when you see your portfolio drop by 50%, you will probably regret being so aggressive. When you answer this question, then you can start designing your portfolio
2 – What type of stocks and why I will own them. If you are an aggressive investor you will probably have a higher allocation on Growth Stocks, but if you are more towards a balanced portfolio, you will probably have more Dividend Stocks and Index Funds.
3 – What are you going to do when the market crashes? Are you going to sell your stocks and move into cash (No!)? Are you going to sell most of your bonds and buy more stocks at discounted prices (yes!)? Are you going to increase your cash contributions to your portfolio (yes!)? Or are you just going to let your portfolio alone, let it ride, forget about it and check only after the market recovers?
I can’t make the plan for you, I can only suggest different approaches to follow when the rainy days comes and the bears take control, but please, make a decision on what are you going to do when that day comes and stick to it! Being prepared will save you from a lot of pain and terrible decisions.
I hope you liked this stock market rules and you stick to them. You can write them down and put it in a place where you can see them everyday, because when the stock market crash happens, I want you to make the best possible decision and maximize your returns when everyone else is panicking.
And this my friends… this is how you make money in the stock market! I wish the best for you and I truly believe that you can achieve financial independence by following this fundamental stock market rules