What if you only needed to make a few small changes to become a better investor?
Well, you can… it’s called kaizen. And it’s incredibly powerful.
Kaizen is a Japanese word that means “continual improvement”. It refers to the process of making positive change and improvement through small, steady steps.
It’s based on the wisdom of Tao Te Ching, a Chinese text famous for the proverb: “A journey of a thousand miles begins with a single step”.
Ask anyone who’s conquered Everest, built a billion-dollar business from scratch, or achieved the seemingly impossible, and they’ll tell you the same thing… they did it a day at a time, step by step.
So what small things can you do today? And how can they make you a better investor?
Start by asking yourself these 3 questions before you buy – anything
As the old Wall Street saying goes: Two factors move the market, greed and fear.
But emotions lead to bad investment decisions. I know that’s easier said than done.
But here’s the good news: Just ask yourself these three questions before you buy anything, and you’ll avoid many of the ways that emotions can be investment pitfalls.
- Why am I investing in it? In other words, what do I need it to do and what return am I going to get from it?
- When am I going to sell? You should sell something when the reason you bought it is no longer valid… either when it has reached its goal or when it’s no longer doing what you wanted it to do in the first place.
- What am I not buying? Every dollar you spend on one investment could have been used to buy something else. Is this the best use of your (sadly not unlimited) budget?
Use stop losses
Even the best investors pick the occasional bad apple. No one gets it right 100 percent of the time. The trick is knowing when to cut your losses instead of hoping for a rebound that might never come.
The key to dodging big losses is to establish a plan for every investment and follow it. And the crucial part of the plan is this: Upon entering every position, while your thinking is emotion-free, figure out your stop loss level.
Before you hit the buy button, take time to think about what percent of your portfolio you’re willing to risk on this particular investment. 2 percent? 5 percent?
Then simultaneously with entry, establish a mental stop-loss order to execute automatically if your stock falls to that level.
The best kind of stop-loss order is a trailing stop-loss. This order “trails” a rising stock by always resting a pre-determined amount (either a percentage or an absolute ﬁgure) below the stock’s most recent high.
For instance, if you bought a stock at $2, and set a trailing stop at 20 percent below that price, then the worst that can happen is you sell at $1.60. But if the stock price goes up to $2.20, the trailing loss (still 20 percent below market value) is now $1.76… and if the stock rises to $3.00 the trailing loss is $2.40.
A trailing stop allows you to “let your winners run,” while keeping a stop-loss order at progressively higher levels as stock moves higher.
Raise some cash
In today’s markets, your cash doesn’t yield much of anything.
But cash is easy. And it’s the simplest way to hedge your portfolio.
You see, the value of your cash remains constant, no matter what is happening with the markets. Cash is steady and stable. (Though over the long term, inflation eats away at the value of your cash, of course.)
But at any time, cash provides flexibility. It’s there when you need to spend it. When obvious investment opportunities come up, you want to be able to take advantage of them. If you don’t have any cash on hand, you won’t be able to.
Avoid doing what everyone else is doing
People tend to follow the herd. It’s human nature to think that if the majority is doing something, then it must be the right thing to do.
This crowd, or mob, mentality is one of the reasons that market bubbles form. Everyone gets excited about a stock or an industry, the media starts talking about it and prices skyrocket. You don’t want to miss out, so you jump on the bandwagon just as prices are peaking… and you end up losing big.
It can work the other way, too. When a market starts to fall, the crowd sells everything because it’s worried about heavy losses. You panic and follow suit, guaranteeing your loss.
So listen to your parents’ advice – just because everyone else is doing it doesn’t mean it’s the right thing to do. Make up your own mind.
Stay invested in the market
“I think a correction is coming, so I’m staying out of the market for now.”
Variations of this phrase are uttered by investors everywhere every day. But there are (at least) two things wrong with this statement…
First: there’s a good chance you’ll be wrong about when markets are going to fall (unless, like a stopped clock, you happen to be coincidentally correct). And sometimes markets give you a bloody nose with a quick 5 or 10 percent slip, but then find their footing again. For most investors, trying to time the market is usually an expensive effort that’s doomed to fail.
Second: You’ll lose out far more by not being at least partly invested than you will with misguided, emotion-fueled attempts to time the market. That’s because stock market returns are extremely concentrated. Blink, and you’ll miss an entire generation of gains. That’s why “I think a correction is coming, so I’m staying out of the market for now” are words that can carry an enormous opportunity cost.
So don’t pull out of the market altogether because you’re worried that there might be a correction.
On their own, none of these small, steady steps is life-changing. But together, thanks to the power of kaizen, they can make you a better (and wealthier) investor.
Kim has nearly 25 years of experience as a stock analyst, hedge fund manager, political risk consultant, and financial commentator in more than half a dozen emerging and frontier markets.
He’s been quoted in the Economist, The New York Times, the Wall Street Journal, Barron’s, and Bloomberg, and has appeared on Fox Business News, China Central Television, and Bloomberg TV, and has written commentary for the Wall Street Journal, Slate.com, Salon, TheStreet.com, breakingviews.com, and other publications.
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