Six rules for investing, whatever the markets are doing

Six rules for investing, whatever the markets are doing

Happily, Montier has the answer – some golden rules to follow that should keep us out of trouble, whatever the level of the markets.

First, always insist on a margin of safety. In other words, don't just buy shares because they're slightly cheap, but because they look really good value. That way you've some protection if your initial forecasts prove too optimistic. And as the old stock exchange adage goes, once you've looked after the downside, the upside will look after itself.

Second, be patient. If you buy a cheap stock and the price refuses to rise, don't panic. You can't know when the market will recognise the share's true worth. It may take much longer than you expected. But value will out in the end.

And just as important, if you can't find an investment that gives you a comfortable margin of safety, then don't invest. As a private investor, you don't have to be chasing short-term performance targets – you can afford to wait for better opportunities.

Third, be contrarian. That may be a bit of a sound bite, but if you can buy when everyone else is panicking and selling out, and then unload your stock when the world is piling back in, you'll do far better than running with the herd.

Fourth, be fully aware about risk. The experts may dress this up using flash terms like volatility and standard deviation. Don't be fooled. Risk, says Montier, is the "permanent loss of capital, never a number". That's another way of saying that if you invest in a stock whose market cap is higher than the underlying company's real worth, you risk never getting all your money back.

Sometimes you can get caught out – a firm's real worth can drop (and no doubt someone will remind me about HMV). But if you've spread your investments across a diversified portfolio, the damage shouldn't be too bad.

Fifth, be wary about leverage, ie investments bought on borrowed money. And that applies to the companies whose shares you're holding. If their debts are high, how relaxed do you feel? Sure, some business – such as utilities with their predictable cash flows – can cope with high leverage. But when times get tougher, many firms can start to struggle with their interest bills. We look more closely at how to analyse this in the latest issue of MoneyWeek, out today. (If you're not already a subscriber, get your first three copies free here).

And finally – and this needs little explanation – never invest in something you don't understand. Pure common sense, you'd think. But it's amazing how many investors get sucked into stocks before they've worked out what the firms actually do.

These are all basic principles of 'value' investing. It's an approach we like at MoneyWeek.

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