Saturday, May 25, 2013

Emotionless Investing: Creating Your Own Investment Rules

The biggest challenge for long-term investors is to control their emotions from making an unsound investment decision. Along the way, there would be a lot of temptations to sell the stock either too early due to fear, or too late to sell when a stock's valuation is clearly overextended. I would argue that the best solution to this is to create your own simple to follow investing rules. By developing your own investing rules, you can basically throw emotions out the window and solely focus on dividend-growth investing.

Here is to give you an example, these are simple rules that I have created and been following ever since.

Sell half of my holdings in a stock when I have gained +30% (dividend accounted) in less than 2 years. The reason why I choose +30%, not less, is because this will restrict myself to only look for stocks that I will be holding for a long period of time and prevent a high turnover rate in my portfolio.

a) If I feel confident in the stock that I sold still has good long-term growth prospects, I should be looking to buy it back at 10~15% cheaper.
b) If that stock continues to go higher without giving me any opportunity to buy back at a lower price, continue trimming down the stock position. Sell another half position if it goes up another +30% in less than 2 years, and sell the entire holdings if it goes up another +33.3%, accounting for dividend as well. Meanwhile, use the proceed to buy other companies that have more reasonable valuations, or buy fixed income assets in waiting for another economic crisis to occur.

Note to self, there is no real urgency to chase winning stocks, there must be plenty of "cheap" stocks out there. As well, the economy is a cycle of boom and bust. There will always be a better time to buy stocks during the next economic crisis. Following these rules will not only help to take the emotion out of investing and help you sleep better at night, but is also a great tool for capital preservation.