5 golden rules of investing to help you thump the market

Investing successfully might be easier than you think.

a woman

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After recently updating some portfolio monitoring software data it surprised me just how high my investment returns are, they're miles ahead of almost every professional fund manager and way ahead of the market.

This comes as a small surprise though, as I don't even invest full time.

I just follow a few simple rules and gather information on stocks from the companies themselves and some reliable sources.

I also shamelessly take ideas from some of my favourite fund managers or stock services, after all any strategy that helps you make money is worth following and these professionals often have the advantage of meeting company management first hand.

Moderately smart people then should be able to achieve excellent returns just by following a few simple rules of investing. Below are some golden rules to follow in the quest to improve your returns and build your wealth.

  1. Don't buy "cheap stocks" or those falling in value – Buying turnarounds or struggling companies is best left to the professionals and a falling share price is a major warning sign the market expects worse to come.
  2. Avoid crap companies –  Excuse my French, but this is probably the golden rule of successful investing. Avoid almost every company that is not turning a profit as a minimum. If you have to speculate on loss makers make sure they have a clear path to profitably and boast gross profitability. If a company cannot make a profit before its capital or growth investments it's an avoid. In Australia the only two loss-making companies I own are XERO FPO (ASX: XRO) and Nearmap Ltd (ASX: NEA), which have gained around 100% and 125% respectively over the past year. Both are operating cash flow positive and have a path to profitability within their current cash reserves. Unfortunately though the ASX is full of companies hungry for your capital. Don't forget a stock exchange is as much a venue to raise capital, as it is to trade shares in businesses. I would say around 90%+ of companies on the local market are not worth your capital, but don't worry that still leaves around 200 to choose from out of around 2,000 listed.
  3. Think long term – retail investors will often hear this mantra, but struggle to appreciate its benefits. In fairness thinking about your investments over a 5 year time frame horizon is almost impossible. Even 3 years seems too long a time to me. So try to think of your investments over 12 to 18 months, as this is realistic and will give time some opportunity to lift share values if the company you own is growing. So you could substitute "think long term" for "don't think short term" as share prices always fall over the short term or from your original buy in price. Remember two people could buy shares in TPG Telecom Ltd (ASX: TPM) today for the same price and one make a 15% loss and the other a 150% gain! Don't let your investments control your behaviour, control your investments with smart behaviour.
  4. Buy growth – As sure as night follows day, share prices follow dividends and profits higher or lower over the medium term. This is not rocket science! When investing look for companies with potential to grow their profits over say a 2 to 4 year time horizon. These companies are actually quite rare and usually possess certain competitive advantages like being a monopoly, Transurban Group (ASX: TCL), healthcare leader Cochlear Limited (ASX: COH) or leader in a growth industry with high barriers to entry, Challenger Ltd (ASX: CGF).
  5. Avoid overpaying for growth – this is one of the commonest mistakes of private investors. Remember investment returns are a function of price paid and if you pay too much for even the world's best company you're returns are likely to be lower than paying a reasonable price for a good growth business. Growth at a reasonable price (GARP) is what you should aim for and learning some basic valuation metrics should help you recognise it.

Of course if you are in the retirement phase and only seeking income from your investments you may prefer to focus on dividends over growth. However, many of the rules still apply in searching out only the highest quality companies built for the long term.

Motley Fool contributor Tom Richardson owns shares of Challenger Limited, Cochlear Ltd., Nearmap Ltd., TPG Telecom Limited, and Xero. You can find Tom on Twitter @tommyr345 The Motley Fool Australia owns shares of and has recommended Challenger Limited, Nearmap Ltd., and TPG Telecom Limited. The Motley Fool Australia owns shares of Xero. The Motley Fool Australia has recommended Cochlear Ltd. and Transurban Group. 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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