How to make money in times of adversity

Published in Investors Edge Magazine September 2011 by Dale Gillham

Over the past two months both the Dow Jones and the Australian market have fallen over 14 per cent - 4 per cent of this occurred just yesterday as panic about the future of the US and world economies washed across world markets.

So how can ordinary Australian's make money when there is all this doom and gloom around?

We have all heard the quote that "If life sends you Lemons then make Lemonade".

When it comes to the share market, Warren Buffet's famous quote is to "Be fearful when others are greedy and greedy when others are fearful", and this is a comment I firmly agree with. But how do you follow this rule?

In my opinion, there is no better time to focus on making money in the share market than following a substantial pull back like the one we are now experiencing, as such a move is always followed by a wealth of opportunity to purchase quality stocks that have been sold down as investors try to liquidate their holdings.

The answer to building wealth is to do what wealthy people do, and this means having a simple plan or set of guiding principles so as not to make investing complex.

  1. Educate yourself and understand what you are investing in: many are willing to spend years studying to gain a formal education with the expectation that they will obtain a job. Yet when it comes to educating themselves about how to create wealth, they never quite find the time.
  2. Don't over-diversify: aim to have between 8 and 12 stocks in your share portfolio as this rule lessens your risk and increases your returns.
  3. Most importantly, learn how to set a stop loss to protect your capital in the event a share falls in value. I suggest 15 per cent below your buy price or 15 per cent below the most recent highest price.
  4. Find out for yourself, don't take tips from others as they are often less educated than you.
  5. Becoming rich through the share market is not about how much you make on any one investment, it is how much you do not lose. If you lost 50 per cent in the GFC then you need to make 100 per cent to get back to where you started. This rule means learn how to sell, and I know having this one rule would have saved the majority of Australians from the GFC.
  6. Do what the rich do and don't follow the masses. The rich don't follow the herd. It's the opposite - the herd attempts to follow the rich. The statistics are that those who are not rich tend to move their money into the market just before the peak and out of it after the crash. Remember Buffet's quote. Now is the time to be greedy and look at buying for the long term, not being fearful and selling.
  7. If you are serious about making money for your retirement or lifestyle, don't make investing a hobby make it your business. After all your boss will not make you rich, that's your job.
  8. Understand the pitfalls with buying investments just for income: don't be lured by high dividends - doesn't make it a safe investment and in current market conditions is often there to attract mum and dad investors who don't understand that it is pointless getting income if the risk to the capital is high.
  9. Don't be a gold digger looking for cheap stocks, remember the tech wreck. Buy only quality stocks in the top 100 shares on the Australian market. Cheap stocks may look attractive but they are often wolves in sheep's clothing.
  10. Don't buy and hold as timing the market is more profitable than time in the market. My research over the years as well as what I have done for my book proves that anyone can achieve good returns with a little knowledge and patience. Buy and hold will only get you poor to average returns, learning to buy and then selling at the right time yields far better returns and lessens risk.

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