Investing legend Glen Arnold says the most important thing investors need to know about investing is that it is based on common sense and can be understood by anyone even with a minimum intelligence level.
According to Arnold, what can make investing complicated are some myths about investment, many of which are spread by finance industry insiders.
He is an investor, businessman, author of many investment and corporate finance publications and professor of finance (part-time) at the University of Salford. He heads a research team focused on stock market mispricing.
Arnold says the first myth of the financial industry is that financial assets and markets are generally complicated and confusing which is actually never the case.
The second myth, as per him, is that investors have to pay large sums to ‘experts’ who then make far greater returns on their money than investors could achieve on their own.
Arnold says although some professionals, in some circumstances, have their uses, the notion that private investors are generally at a disadvantage to the professionals and should always defer to their superior insight is just wrong.
“As for the argument that you need to employ an ‘expert’ to run your investments –well, this is complete nonsense. For a start, the majority of professional fund managers underperform the stock market. This has been observed year after year,” he says.
Arnold says the third myth is that only wealthy people can afford shares and other financial assets but in reality people of relatively modest means invest in the stock market.
Essential qualities of a good investor
Arnold says investors need some basic knowledge, and also some dedication to perform their investment tasks. Also, investors need to have a down-to-earth focus on their investments and need to use some sound investment tools for superior returns.
Arnold explained some investing principles in his book The Financial Times Guide to Investing: The Definitive Companion to Investment and the Financial Markets which can help young investors achieve superior returns. Let’s look at some of these tips:
Be a business analyst rather than a security analyst
According to Arnold, a share is not a gambling counter in a short-term random game of chance, it represents ownership and its value depends on what will happen to that company years from now.
“Investors need to understand the underlying business, not focus on stock market price movements. Be a business analyst trying to understand what makes it tick, rather than a share analyst. Share investment is about businesses – when you buy a share you buy a portion of the ownership of a business,” he says.
Do your homework
According to Arnold, not only must investors be prepared for hard work to analyse individual companies, but they must develop a broad social, economic and political awareness.
Control your emotions
Arnold says investors should develop the mental strength to withstand being carried away with the rest of the market when it becomes over-excited or overly depressed.
“Investors need resilience, self-discipline and courage. There will be long periods when patience is required, interspersed with the need to act decisively,” he says.
Keep it simple
Arnold says the key components of investment decisions are essentially simple and investors shouldn’t over-complicate.
“None of the great investors use the complex modern portfolio theory constructs such as the Capital Asset Pricing Model with its beta analysis. True investment value should scream at you, so detailed and complex calculations are simply not necessary to give you the required margin of safety. All the math you need you picked up before you were 16,” he says.
Constantly learn from mistakes
Arnold says even those great investors now in their 80s learn new things every day, often from mistakes.
These can be mistakes (a) of omission (e.g. Warren Buffett is forever publicly berating himself for missing a great opportunity (b) of commission (buying a share that turns out to be a bad investment), and (c) of others – learning from the mistakes of others.
“You will find that the great investors are constantly reading and learning (biography, science, stock market history, newspapers as well as company reports) – they just never stop developing their minds,” he says.
Arnold says investors should have the self-belief which can come only from years of focused hard work and knowledge.
“They can then stand aside from the crowd and go with their own logic,” he says.
Have a reasonable risk taking attitude
Arnold says investors should avoid gambling and should make rational, careful analysis of the major risk factors and make moves when the odds are tilted in their favour.
“Mistakes and misfortunes are inherent in investing – even great investors are wrong more than 40 per cent of the time. They are careful to always be diversified so they are not risking a high proportion of their money on one outcome,” he says.
Arnold says the market often sets prices that are far from the true value of the business.
“Be independent, evaluate firms and exploit market prices rather than be led by them,” he says,
Invest, don’t speculate!
Arnold says investors should thoroughly analyse to understand the business, only buy when reassured of the safety of the principle and should aim for a satisfactory return, rather than over-reaching for extraordinary returns.
“Operations not meeting these requirements are speculative. Speculators focus on guessing short-term price moves,” he says.
Don’t pay high fee
Arnold says fund managers can take away the bulk of the investment gain.
“Fees of 1.5 per cent sound low, but can remove one-third of your gain. A fund manager charging 1.5 per cent per annum better pack some real dynamite, when ETFs charge only 0.3 per cent,” he said.
Diversify, but not to mediocrity
Arnold says investors are vulnerable if they invest in only one share, so they should diversify.
“Beyond 10 the benefits of further diversification become small. Better to concentrate your knowledge and hone your analytical edge,” he said.
Read the philosophies of great investors
Arnold says investors should learn from great investors and use their hard earned experience of what works and what does not.
“Enjoy the journey as well as the proceeds, because the journey is where you live,” he says.
Arnold says investors should enjoy investing and if they don’t enjoy it then they should hire someone else to do it for them if charges are reasonable.
(Disclaimer: This article is based on Glen Arnold’s book “The Financial Times Guide to Investing: The Definitive Companion to Investment and the Financial Markets” )