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How to become financially independent 11: Laws of Investment Part One

This is one of the most important of all the laws of money. You should spend at least as much time studying a particular investment as you do earning the money to put into that particular investment. Never let yourself be rushed into parting with money. You have worked too hard to earn it and taken too long to accumulate it.

Investigate every aspect of the investment well before you make any commitment. Ask for full and complete disclosure of every detail. Demand honest, accurate and adequate information on any investment of any kind. If you have any doubt or misgivings at all, you will probably be better off keeping your money in the bank or in a money market investment account than you would be speculating or taking the risk of losing it.

James Montier, recently published a white paper titled The Seven Immutable Laws of Investing. The paper addresses what he sees as the seven truths or principles that should guide sensible investors.

1.      Always insist on a margin of safety

Valuation is the closest thing to the law of gravity that we have in finance. It is the primary determinant of long-term returns. However, the objective of investment (in general) is not to buy at fair value, but to purchase with a margin of safety. This reflects that any estimate of fair value is just that: an estimate, not a precise figure, so the margin of safety provides a much-needed cushion against errors and misfortunes.

2. This time is never different

The more things change, the more they stay the same; it’s easy to forget that sometimes and to think that we are working with a new paradigm, especially one in which prices continue to rise far above their long-term trend lines. Rather than throwing out the handbook of investment, we may be better advised to stay true to the principles that have guided sensible investments since time immemorial.

3. Be patient and wait for the fat pitch

In words often attributed to Warren Buffett, “The stock market is a wonderfully efficient mechanism for transferring wealth from the impatient to the patient.” Montier makes the point that far too much emphasis is placed on annual, monthly, or even daily performance, when really we should be focusing on the longer term. We should also be on our guard against “action bias” — the desire to do something. This is arguably easier for private investors, who don’t have the same requirement to appear busy.

Patience is also required when investors are faced with an unappealing opportunity set. Many investors seem to suffer from an “action bias” – a desire to do something. However, when there is nothing to do, the best plan is usually to do nothing. Stand at the plate and wait for the fat pitch.

Instead we should wait for the “fat pitch,” the ball that we really should play, rather than playing every ball that comes our way regardless of quality.

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