The Motley Fool

How to avoid lagging the market as a new investor

I’m not one for eavesdropping, but as I sat in a coffee shop last week I overheard a brash and booming business meeting being conducted a few tables over. “Half of selling,” said a suited up fellow, “is knowing the correct technical terms to impress.”

What were they discussing? Perhaps unsurprisingly, it was a financial product. Aside from making my blood boil, this conversation reminded me that much of the financial industry exists to bewilder, to bewitch and to befuddle you.

The more complicated finance seems, the more likely you are to outsource wealth management to highly profitable financial institutions.

If you’re new to investing and lagging the market, it might not be your fault. There’s so much information out there and most of the pros want to keep their secrets locked up.

Today I’ll try to demystify the apparently complicated, yet wonderfully simple world of investing. Here’s a few pointers that might help you get to grips with this deliberately opaque industry.

Have a simple plan

Some fund managers will try to impress by talking about hedging, shorting, derivatives etc… but you can completely ignore all these complicated and often unnecessary practices and still make a killing by following three easy steps;

  1. Buy a diversified portfolio of good companies
  2. Hold them for a long time
  3. Profit

That’s all there is to it, but let’s break those steps down a bit more.

What’s a great company? In my opinion, they all share one kind of asset, a durable competitive advantage. This is a feature, be it a great leader, a great product, a great brand, that sets the company apart from the competition. Most importantly, this feature must be sustainable in the long term.

Coca-Cola has been outselling other drinks for decades and out-performance has followed. That’s a durable brand. If the advantage isn’t durable, the share price appreciation caused by it might not be either.

I recommend holding around 15 great companies whose operations span different sectors and geographies to ensure you spread risk. Holding these companies for years rather than days reduces dealing costs, which at £10-£15 a pop can seriously erode your wealth.

It’s a numbers game, kind of

You need a basic grasp of accounting to find great businesses, but you don’t need to be conducting discounted cash flows in your sleep to be successful. Not even Warren Buffett, who owns many great companies, employs these complicated tools. Accounting can be scary and you’ll have to do a little bit of research to understand it, but only a little.

The wonderful book Warren Buffett And The Interpretation Of Financial Statements will teach you almost everything you need to know in an incredibly accessible and contextual style. In case you’re wondering, I’ve not been sponsored to say that. In my opinion it’s the best book to help beginners find financially great businesses.  

You’re human, dispel your ‘animal spirit’

You’re not a bull, nor a bear. You’re a rational human being with emotional control. Buffett’s partner (and my hero) Charlie Munger often talks about the psychology of human misjudgement, or what makes us screw up. In short, the human mind isn’t wired to invest, resulting in wealth-eroding errors. Being aware of these in-built flaws will prevent you falling afoul of them.

With this in mind, we asked our top analysts around the globe to tell us about their worst mistakes. The resulting report details some of the biggest pitfalls in investing and could help you avoid disastrous decisions.

To access this report, click here. Finally, I'd like to wish you luck on your investing journey. Keep working on your idea generation, accounting literacy and emotional control and you'll become a great investor.