Starting out

A simple five-point plan can put the keen amateur on the right track

STORY GREG HOFFMAN

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BENJAMIN GRAHAM IS one of my investing heroes (and Warren Buffett’s professor). In his book, The Intelligent Investor, he wrote that most people should be “passive investors” in the sharemarket, simply hoping to match the market’s return by diversifying widely and keeping their costs as low as possible.

Graham labelled those aiming to beat the market as “aggressive investors” who needed to bring a lot of skills, time and effort to the task. Here’s his pithy summary of the difference: “To achieve satisfactory investment results is easier than most people realise; to achieve superior results is harder than it looks.”

In other words, Graham advised investors to make a choice between two very different paths: the hands-off, low-effort road of the passive investor or the hard graft of the aggressive investor. And from a purely rational point of view, he was dead right.

The sharemarket is a competitive arena and aiming to beat the average result is a goal that requires serious effort. But what if you like the idea of doing some active investing without devoting every hour of leisure time to the task? What if you simply want to buy a few stocks primarily for the intellectual stimulation, challenge and, hopefully, some financial gains?

This is an understandable desire. In fact, it probably captures the bulk of the members who subscribe to the Intelligent Investor Share Advisor service I oversaw for a decade. So I’d like to propose adding a third category to Graham’s bipolar spectrum: the keen beginner, or enthusiastic amateur.

Some people watch birds or spot trains, others collect sports memorabilia. The sharemarket can be every bit as engaging and rewarding as those pastimes. And there might even be a handy profit in taking it up as a hobby.

So this article is dedicated to the keen beginner, to whom I offer a five-point plan.

1. Develop a philosophy

This is key because without one, you’ll be prone to drifting around from approach to approach or fad to fad.

Some people are traders or chartists, or “technical analysts” as many prefer to be called. I started out as a chartist and made a little money from it. But I was instantly converted upon learning about value investing in 1996. It’s the idea of treating a share as a small part of a business, determining its value as best you can and aiming to buy it at a discount to that “intrinsic value”.

Find an approach that sits well with your intellect and personality and stick with it long enough to make a reasonable assessment of whether you’re practising it effectively (it might take 18 months to two years before you start to get a good feel for that).

2. Approach the market in a businesslike manner

This is another piece of advice from Ben Graham and, while it applies most directly to value investors, I think his words are relevant to traders or technical analysts. He advised that the principle is to “know what you are doing – know your business”. Explaining what this means for investors, he said: “Do not try to make ‘business profits’ out of securities – that is, returns in excess of normal interest and dividend income – unless you know as much about security values as you would need to know about the value of merchandise that you proposed to manufacture or deal in.”

I’d add another dimension – risk management. In the same way as astute business people aim to identify and protect against risk, so should the investor, no matter what their philosophy. For us value investors, risk management comes from buying at a low price, conducting thorough research and maintaining thoughtful diversification. Traders and chartists should develop their own methods for mitigating the risks they take on.

3. Follow stocks you know something about

With thousands of shares to choose from, it makes sense to start with those stocks you have some prior knowledge of. It’s also in keeping with our second point.

Perhaps you’ve worked in a certain industry or as a supplier to a particular business. Or maybe you’re a customer. What matters is that you have some insight that puts you ahead of simply staring at a blank page when starting your research.

I’d also advise that you steer clear of industries with complex accounting, unless you have a good understanding of it. This rules out insurance and banking stocks for most beginners. Even if you work in those areas, if you don’t understand the accounting you must be very wary.

Retail is generally a good industry to start with as the accounts are typically straightforward, the business models relatively simple and most of us interact with the brands on a regular basis. Harvey Norman is one exception to the rule here – its complex “franchise” arrangements and property ownership make the accounts rather complicated. JB Hi-Fi, Myer and David Jones are better options for aspiring investors to start analysing.

4. Keep abreast of what’s in the business media

To this you might also add “and what’s not in the business media”. The best opportunities are often neglected or even maligned by the media. While the headlines shouldn’t dictate your investment path, it’s important to keep up with industry trends and changes.

Perhaps you’ll read that an outstanding manager you once worked for has gone to run a listed company. Or maybe you’re a brand expert who has good reason to believe the long-term value of a beaten-down icon like Billabong is being overlooked.

5. Write an investing diary

This simple, practical tip is devastatingly effective. I can recommend it from first-hand experience. And the younger investors I’ve mentored over the past decade have benefited from it as well.

Understanding and assessing your emotional and intellectual reactions is crucial to developing into an investor with five or 10 years’ experience, rather than an investor with one year’s experience lived five or 10 times over.

I recommend writing diary entries at least weekly, if not several times a week. After a while you’ll start to notice patterns in your behaviour. For instance, are you inclined to panic when the market falls out of bed? This is valuable information to understand about yourself and will help you improve over time.

So there you have it: a five-point plan for the keen sharemarket beginner. If you’re a bit stuck on where to start with the first point, I recommend reading about some famous investors and seeing if any of their stories strike a chord with you.

A few books you might consider are Buffett: The Making of an American Capitalist by Roger Lowenstein (the book that changed my life), One Up on Wall Street by Peter Lynch and Soros: The Unauthorized Biography, the Life, Times and Trading Secrets of the World’s Greatest Investor by Robert Slater.

A final point is that you must accept that you’ll make mistakes. Learn to review them rather than beat yourself up. Take what you can from the experience and move on. Above all, enjoy the journey. In my view, it beats the heck out of sitting around train stations noting varieties of rolling stock!

Greg Hoffman is an independent financial educator, commentator and investor. He is a director of the Intelligent Investor group of companies.

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