Investing Principles: Top 5 Principles to Investing

How to start investing

Taking your first step into investing can be daunting, especially when there are thousands of opportunities to choose from. So, before you get started, work on developing your own investment philosophy – a core set of beliefs designed to guide how you invest over the long term.

Knowing how and why you invest can be helpful when markets are volatile, and your beliefs don’t need to be set in stone either: many successful investors like Warren Buffett have sharpened their own investment philosophies over time.

Top five investment principles

There are some key investment philosophies commonly championed by successful long-term investors.

Principle one: invest in what you know.

This is the most important rule of investing: always do your homework. It’s dangerous to simply follow the crowd: you could find yourself caught in bubbles where prices can fall just as quickly as they rose. Instead, look for quality companies that generate strong cash flows and are easy to run, and consistently evaluate your investment thesis to make sure your portfolio’s risks are widely spread and well-hedged.

Principle two: patience, not genius, is key to success.

You’ll need lots of patience if you’re working toward a long-term investment goal. Prices may fluctuate wildly every day, but you should be prepared to buy and hold for a while: as famous value investor Benjamin Graham once said, ‘In the short run, the market is a voting machine, but in the long run, it’s a weighing machine.’ Put simply, if you’re patient enough to ride out the noise, an asset’s underlying value may well be recognised by the market in time.

Principle three: value is important.

No matter how wonderful a company is, overpaying for its stocks would put your returns on the line. The goal, where possible, is to buy performing companies’ stocks at low prices: that not only increases the potential of higher returns in the future, but that margin of safety also reduces the risks of things going wrong.

Principle four: time in the market beats timing the market.

It can be tempting to pull your investments entirely when markets are in the red. But that could actually hurt your returns, since many of the best market days occur during or immediately after downturns. In fact, research has shown that missing the ten best trading days in each of the last 15 years would have cut your returns by over half, versus staying fully invested throughout.¹ So because no one can consistently predict market turning points, it’s best to remain invested – with a well-diversified portfolio – through the good and the bad.

Principle five: ‘be fearful when others are greedy, and greedy only when others are fearful.’

Warren Buffett made that quote popular back in 1986. It just about sums up the basic principles: avoid following the crowd, do your homework, and don’t be afraid to buy when others are fearful of getting exposure – it’ll just give you a better chance to buy great companies at even better prices. So even when markets are as weak as they are now, you can see it as an opportunity to pick up quality assets at cheaper prices.

Investment styles explained

Once you’ve established your core set of investment beliefs, you can start thinking about your strategy. Which style you choose will greatly influence the type of investments you make, so here are six common ones that you should be aware of.

Value investing

This strategy favours stocks that are undervalued by investors, and trade at a significant discount compared to the market (for reasons that may or may not be justified). You’ll need loads of patience and grit for this one, as you’ll have to go against the market for some time before your stock’s value is recognised.

Growth investing

Growth investors focus on fast-growing companies that can outpace the market – think tech stocks Amazon and Netflix from 2019 to early 2022. These stocks tend to come at a relatively high cost, and they pay lower dividends compared to value stocks.

Quality investing

Quality companies that compete in industries with high barriers to entry and low competition are the focus of this strategy. The main objective is to find robust companies that can do well in all market conditions, and boast good management, a solid balance sheet, a strong returns profile, and stable earnings.

Thematic investing

This strategy identifies companies across a wide range of sectors that are united by a particular theme. For example, an investor who backs the rise of electric vehicles could build a portfolio that includes auto companies, battery providers, and copper miners, to name a few.

Income investing

Income investors seek companies that can sustainably and consistently pay high dividends over the long term, with the aim of generating a consistent income stream from their investments. This strategy tends to focus on companies in mature industries with strong cash generation.

Index investing

This is a low-cost, passive strategy that allows investors to easily diversify across markets. Investors who want to replicate the performance of a specific market or index can typically do so through index mutual funds or exchange-traded funds (ETFs).

How to pick the right investment style for you

Index funds are one of the easiest ways to get into investing: they ensure you’re properly diversified and allow you to make returns that are largely in line with the market. Besides that, your investment strategy will ultimately depend on your risk appetite, life stage, investment horizon, and investment goals.

If you’re nearing retirement and want a steady stream of income, you might lean toward income investing – that’s focusing predominantly on defensive stocks with lower volatility. That said, investment strategies often overlap, and one single stock could feature in more than one strategy. You could build multiple portfolios with different strategies, and experiment to see what works best for you.

Investing in today’s macro environment

The popularity of any investment style usually hinges on the changing macro environment. During the low interest rates of the last decade, growth investing was popular for its high returns. After all, companies could borrow at a low cost to fuel their growth. But times are changing: inflation’s rising and central banks are hiking interest rates, and value investing is gaining fresh popularity.

High-growth stocks tend to suffer more than low-growth ones in rising-rate environments, because they derive most of their present value from future growth and cash flows. Put simply, higher rates impact their share prices more.

Income investing could come back in style during an inflationary environment, as investors look to make inflation-busting returns despite a volatile environment. And in times of low growth and high volatility, investors might prefer to invest thematically, especially in long-term trends like sustainable energy, ageing populations, or digitisation.

Footnotes:

¹ Putnam, 2023