10 Golden Rules of Investing: How o Secure Your Financial Future

For an intangible entity, time is starkly palpable. It seems to strum with glee when you make swift gains in the market; it's a sentient savant when you suffer losses; it can be an irksome sprinter for the ageing saver; a sluggish bore for a young trader. But mostly, time is a capricious companion, loyal to none, yet equanimous to all.

We, at Trust Capital, have not been immune to its caprices, swept as the rest into its contrarian fold. So, during the economic slowdown, into which we stepped with our launch on 13 December 2010, we felt laden with our readers' expectations. However, two years later, having navigated you through financial undulations, we feel leavened by your response. Through it all, we have tried to maintain our own equanimity, which stems from our acute perception of your needs and the deep insight into personal finance. Between fielding time's whimsies and setting you on the right course, we have reached another milestone - we have turned two. It's a special occasion because in this short span we have learnt to tweak time's truancy to our advantage. In its contortions, we have found a constant.

We call it the Golden Rules of Investing. A synthesis of the past learnings, these principles are our way of celebrating the present by securing your future. The mark of any rule is its universality and ability to transcend time. What we have framed for you are 10 canons that are based on these benchmarks, a compilation of our previous stories. They will act as a bulwark for your finances against the attenuating swipes of time. They will hone you into an aware investor in sync with your needs.

Most importantly, they will help you grow your wealth, so that we can keep the promise we made at the time of our launch - that we would lead you to riches in this golden decade of investing. In the following pages, we will tell you how to build a safe portfolio; how to work towards a fret-free retirement; ways to defend against the crushing impact of the unforeseen; how to juggle your portfolio and when to cut your losses; how to deal with the trap of taxation; how to make the distinction between insurance and investment; the much-brandished benefits of diversification, and why you need to factor in the eroding effect of inflation.

In essence, we offer a seminal guide that spans the gamut of personal finance. Still, our work remains unfinished. For, even though the country's fiscal fate appears to be altering, thanks to the proposed reforms, the world has not quite remedied its economic ills. And while regulatory activism spells hope for the small investor, the responsibility to secure your finances ultimately rests with you. So time shall continue to remain a pulsating presentiment and will not stop throwing challenges at you. But you shall not be alone; we at ET Wealth will guide you through all your financial travails. And together we shall learn to tame time, perhaps even befriend it.

Rule 1: Know your worth before you begin

To reach the finishing line, you must first know where the race begins. As any financial planner will tell you, figuring out your net worth is the first step towards formulating a successful financial plan. The best way to do this is by drawing up a list of your assets and liabilities. Use the table on the right to calculate your net worth.
It will also give you a broad idea of your current asset allocation. Taking stock of your current status is necessary to help you make informed financial decisions. The slowdown may have affected your annual increment. Volatility in the stock market may have prompted you to stay out. Before you plan to invest, sit down and take a fresh look at your financial situation. Once you have figured out where you stand, find out your attitude towards investing. Your ability to take risks determines the investments you should opt for. If your stomach churns whenever the Sensex goes into a freefall, equity is not for you.
Stick to the safety of debt options or take exposure to stocks through mutual funds. On the other hand, if a 20-25% fall in value doesn't upset you, equity can be a great way to build wealth. Another important trait is the keenness to conduct research before investing. Some people love nothing more than digging into financial statements and crunching numbers, while others might not have the time or inclination to plough through prospectuses and product brochures.
 

 

Rule 2: Don't invest in a product you don't understand...

Most of the people who write to us seeking financial advice have investments they don't understand. They are likely to know every random feature of their Rs 8,000 cell phone, but will be clueless about their insurance policies that are worth lakhs of rupees. Before you invest, you must fully understand how the product works and how you will gain from it.

There are several products (especially insurance plans) that promise the moon and have complex features. Avoid these sophisticated products if you don't understand them. Investing in something that you do not understand is gambling with your money. Instead of the structured products being sold in the market, the humble PPF can also help build enormous wealth in the long term. Increase the investment by just 1% every year and you will have a comfortable retirement.

...but don't skew your portfolio in favour of one asset

The above-mentioned investment rule does not imply that you concentrate your investments in one or two asset classes. You may not understand equity, but this should not stop you from investing in equity mutual funds. As long as you understand that the fund manager will deploy your money in the stock market and your investment will move with the market, it is good enough. There are investors who buy nothing but gold, or invest only in bank deposits.

Some invest only in real estate having been conditioned into believing it is the safest asset. The biggest problem with a concentrated portfolio is that a single crash can make you bite the dust. We saw this happen in 2008 when the equity market crashed. As the chart below shows, a diversified portfolio cushions the risk and generates stable returns. So opt for diversification.

Rule 3: Do not invest and forget

Don't think your work is done after you make an investment. In fact, it has just begun. You need to monitor and review your investments and take corrective measures if they go off the track. At least once a year, you should subject your portfolio to the financial equivalent of a CT scan. The outcome may not be very palatable, but some tough decisions are needed to keep the portfolio healthy.
The first thing to check in your portfolio is asset allocation. It could have changed because of the market conditions and, perhaps, needs to be rebalanced. For instance, you may have wanted to allocate 60% of the corpus to stocks, 30% to debt and 10% to gold and other investments, but due to a fall in the equity market and rise in gold prices, the portfolio now has 45% in stocks, 40% in debt and 15% in gold. You need to increase your allocation to equity by buying some more and reduce the investment in debt and gold. The next thing to consider is the performance of individual investments.
Take help from brokerage reports, news reports and expert comments when you size up the stocks in your portfolio. For mutual funds, compare the scheme's performance with that of its peers and benchmark. If you find it difficult to analyse your portfolio, or if your investments are too disparate, take the help of an online portfolio tracker or money manager websites. Besides, you need to keep your goals in mind when you review your portfolio. The exposure to volatile assets should come down as you draw closer to a goal.

Review portfolio in case of special situations

Experts say you should review your investments once a year. However, some extraordinary circumstances may require you to rejig it even earlier. Here are a few such special situations:

Marriage

Wedding bells mean new goals, higher expenses and a change in risk profile. Your investments need to be overhauled. If your spouse also works, your investible surplus will go up. Chalk out a combined list of goals and plan your investments to reach them.

Birth of a child

The entry of a new member in the family means additional responsibilities and expenses. You will add new goals to your list and, therefore, need to change your investment pattern. This may also require you to increase your life insurance cover and establish an emergency medical kitty.

Salary hike

When your income goes up, your investible surplus rises. Ideally, you should distribute the excess amount across different asset classes in the same proportion as your investment mix. You can increase the SIP amount in your investments. You may also want to add a financial goal to your list.

Windfall

Any unexpected income or an annual bonus coming your way is another reason to change your investment portfolio. If the money comes to you as a lump sum, put it in a debt fund and start a systematic transfer plan to an equity fund.

Loans

If you have taken a loan, put off some of your investments to account for the EMI outgo. Rejig your investments by putting the non-essential goals on the backburner till the loan is repaid. When you repay a loan, you will have a bigger surplus to deploy.

Black swan situations 

A sudden movement in the stock market, such as the crash of 2008, may warrant a change in your investment portfolio.
You may need to rejig your asset allocation before a year to adjust to the change in the market sentiment.

   

Rule 4: Look beyond price and past returns for real value

It is every investor's dream to buy a stock when it is priced low and sell when it zooms. However, small investors take this a little too literally and buy penny shares trading at very low prices. The price of a share is not an indication of its real value. A stock at Rs 5 may actually be costlier in value terms than one trading at Rs 500.

Low price alone does not mean that the stock offers good value. To find out if a stock is fairly valued, compare it with its peers on a few common parameters. Though the PE ratio is a good way to identify cheap stocks, relying only on a single parameter may not always yield the desired results. What you consider cheap in relative terms might actually be more expensive, and vice versa. Investors have lost money in many seemingly cheap stocks, while high-priced stocks have given spectacular returns (see tables).

This is because many of these low PE stocks may actually be costlier than their high PE counterparts, based on other fundamentals. A high PE stock could be justified if the company has high growth expectations, strong fundamentals, or has huge projects or investments in the pipeline. A low PE stock, on the other hand, may be so valued because of poor earnings growth, weak fundamentals or lack of further expansion opportunities. This argument is stronger when it comes to mutual funds. Some investors think mutual funds with low NAVs are cheap. A fund at Rs 25 is not cheaper (or better) than one priced at Rs 250. The low price only means it is newer. Your returns will depend on how the fund performs, which, in turn, will depend on how the market moves.

Rule 5: Factor in inflation while calculating returns

Inflation affects everyone and its impact on the household budget is widely understood.

However, very few investors understand the impact of inflation on their investments.

This is a mistake because inflation should be factored into every calculation of your financial plan.

Even a modest 5% annual inflation can widen the gap between your nominal and real income to almost 20% in just five years.

Over 40 years, this difference can widen to over 80%. So, don't plan your future based on nominal values.

Factor in inflation to know the real value of your income and investments.

The post-tax returns from a bank deposit, which offers 8.5% interest, will not be able to match the rise in prices.

This is why planners don't recommend low-yield debt investments for the long term. Instead, they advise clients to take at least 15-20% exposure to equities to be able to beat inflation.

Inflation should especially be considered while planning for long-term goals like retirement and children's education.

Also take into account the fact that your consumption basket changes over the years. When you are single, education and healthcare inflation do not impact you (see graphic).

However, when you start a family, education expenses shoot up. As you grow older, healthcare accounts for a progressively larger portion of your expenses.

Insurance is another area where inflation should be taken into account.

 A Rs 1 crore insurance cover seems sufficient right now, but this might change when you factor in inflation.

Even 6% inflation will reduce the purchasing power of Rs 1 crore to Rs 40 lakh in 15 years.

Rule 6: Buy insurance to guard against the unforeseen...

No matter how careful you are, an eventuality can play havoc with your finances. It could be a medical emergency that racks up a huge bill or the death of the family's breadwinner. The only way to deal with these mishaps is to protect yourself adequately. Insurance is a cost-effective way to safeguard yourself against the unexpected. In fact, life insurance is one of the most important ingredients of a financial plan. This one instrument secures all your financial goals and aspirations. One should have a cover of at least 5-6 times one's annual income. However, this is a rudimentary method and a more accurate calculation must take into account your expenses, current assets and future financial goals. Use the table below to find out the size of life insurance cover you need. Medical insurance is also very important.

The rise in cost of healthcare means that even 2-3 days in hospital can cost Rs 50,000-60,000. A medical cover will not prevent illness, but it will allow you to access the best hospital in your city without burning a hole in your wallet. Take adequate health cover for your family and yourself. If your employer offers you medical insurance, take a top-up plan to enhance it. A personal accident cover is a little known, but crucial, form of insurance. It covers loss of livelihood due to disability, temporary or permanent. Life insurance is payable only in case of death and medical insurance covers hospitalisation expenses, but these policies will not pay anything if a person loses a limb in an accident or has to miss work for a long period due to injuries. This is where personal accident insurance will come to his rescue.

...but don't mix insurance with investment

Buying life insurance as an investment is probably the most common mistake stemming from ignorance. A life plan should be taken merely to secure one's dependants in case of one's demise, not as a returnbearing investment. So, a unit-linked insurance plan or a traditional insurance policy will not be able to give you adequate protection since a large chunk of the premium goes as investment. Instead of these high-premium plans, which combine investment with insurance, buyers should opt for term plans. These are pure protection policies that charge a very low premium for a very high insurance cover.

For less than Rs 12,000 a year, a 30-year-old nonsmoker can buy an insurance cover of Rs 1 crore. If you buy online, the premium is even lower. Term plan premiums are low because there is no investment involved. These policies don't pay anything if the policyholder survives the term of the plan. On the other hand, a Ulip that offers a cover of Rs 1 crore will have a premium of Rs 8-10 lakh, while a traditional plan will cost roughly Rs 12 lakh.

Rule 7: Don't leave tax planning till end of financial year

It is a perennial problem. Taxpayers wake up in March when their employer sends them a notice seeking proof of their tax-saving investments. In the rush to complete their tax planning before the 31 March deadline, many taxpayers make hasty decisions they regret at leisure. Unscrupulous insurance agents thrive on this panic. This is the time when they can mis-sell high-commission products without the buyer asking too many questions or examining the product in detail. Who would want to go through the policy features in small print when the premium receipt has to be submitted to the office the next day?

This is a penny wise, pound foolish approach. If you buy an insurance policy that doesn't suit you, the entire premium goes waste. To save Rs 2,000-3,000 in tax, you could be throwing away Rs 10,000. Your tax planning should not be a kneejerk event that happens in March, but a part of your overall financial planning. Instead of packing your entire tax planning into March, spread it across the year and take informed decisions. You should buy an insurance plan only if you need life cover. Invest in an ELSS fund only if you need to take exposure to stocks. Lock money in the PPF, an NSC or a bank fixed deposit if you want to invest in debt. Take a health insurance plan if you need medical cover, not because you get deduction under Section 80D. The tax benefit is incidental, not the core.

Rule 8: Be prepared for a financial emergency

Will you be able to manage your finances if you lose your job today? Financial planners advise that one should have a buffer fund to take care of a financial emergency. This contingency fund should be large enough to meet at least three months' worth of household expenses, including loan repayment and insurance premium obligations. An emergency fund should be easily accessible and its value should not be subject to fluctuations. While an investment in equity funds is fairly liquid, its value can go down when the funds are needed and beat the purpose of having such a corpus. Similarly, a home equity loan pre-supposes an appreciation in the value of property, which may not always happen. A loan will also push up the EMI, which might be tough when somebody is facing a loss of income. Although credit cards are commonly used for emergency funding, they are useful if you restrict the credit to one month. Otherwise, the cost is prohibitively high.

...but do not keep all of it in cash

While the need for a cash cushion cannot be stressed enough, the problem is that many of us hold much more than is needed for our short-term needs. Whether it is in your pocket or in a savings bank account, you incur costs. For one, the opportunity cost of holding cash is high since you forego the chance to invest it to earn a higher rate of return. More importantly, the cash in your account will lose value if you take the adverse impact of inflation into account. If adjusted for inflation, the return from a savings bank account will always be in the negative. Then there are the psychological costs of holding cash.

If you are not a disciplined spender and have a fat bank balance, it's quite likely that you will give in to temptation and spend on discretionary items. Apart from the emergency fund, there is no need to have more than 5-10% of your entire investing portfolio in cash. Financial planners say this extra cash should be put to work. A mix of short-term investments can help you retain liquidity as well as earn better returns. Depending on one's personal situation, one can park the remaining amount in a short-term avenue, which is almost as liquid as a bank account. For instance, debt fund redemptions reach your bank account the next working day.

Rule 9: Give precedence to retirement savings

One of the biggest challenges for tomorrow's retirees is to ensure that they don't outlive their savings. This is a distinct possibility because of two factors: the rising cost of living and an increase in life expectancy.

However, for many Indians, retirement is not as crucial as saving for their children. Whether it is for their education or marriage, or even to provide them with a comfortable life, children are the biggest motivators of savings in the country.

This can be a problem because your retirement is going to be very different from that of the previous generation.

Guaranteed pension, assured return from government schemes, relatively low inflation and the security of a joint family - the four pillars on which the previous generation's retirement planning rested - have either gone or will disappear soon. What's more, you will live longer, thus heightening the risk of outliving your money.

Before you pour money into a child plan, make sure your retirement savings target has been met. Retirement planning should be your first and most important financial goal.

By this we don't mean you should neglect your child's needs, but you can borrow for almost all other goals, such as child's education, marriage or going on a holiday.

No one will lend you for your retirement expenses though. The early birds, who start putting away small amounts from the day they start working, have a distinct advantage over lazy grasshoppers, who think of retirement planning only after the first grey hair makes an appearance in their 40s (see graphic).

It is also important that you don't dip into your corpus before you retire. Withdrawing money from your PPF account or missing the premium of a pension plan can lead to a shortfall in your corpus.

If you want a dignified retirement, resist the temptation to withdraw from the investments earmarked for your sunset years.

Rule 10: Learn to cut your losses

Many investors believe that if they select a good investment and time their moves well, it is enough. However, the decision to sell, especially at a loss, is not as easy. Financial experts say that the small investor's portfolio suffers more due to incorrect decisions that are not rectified in time. Holding bad investments may be worse than not selecting the right ones. To be a successful investor, you need to have a selling plan in place and book losses if the situation so demands. Behavioural economists contend that our refusal to sell an investment stems from our aversion to loss. If our investment turns out to be good, we are happy to sell and feel good about the gains. However, booking a loss is painful, so we tend to postpone the regret we feel at having made the wrong decision.

We choose to wait out, ignore, or worse, add more to a poorly performing investment, hoping to average out the cost. Therefore, cleaning up a portfolio is a tough task and calls for rational decision-making. Low-yield insurance policies, dud stocks and poorly selected mutual funds don't offer any value to the investor, but there is a deeprooted aversion to get rid of them. Many of the wrong decisions are taken when everything is looking upbeat. Those who bought obscure infrastructure stocks at the height of the 2007 euphoria are still holding them, hoping that they will be able to recoup their investment one day. Little do they realise that this is a drag on their portfolio's overall return. Had they booked losses in 2008 and shifted the money to any average index-based stock, they would have got something back. It is also important not to throw good money after bad. Don't book profits on good investments just to plough it back into underperformers. You will only be left with lemons. It is better to ride the winners than pump more money into losers.

TECHNICAL VIEW FOR 21st FEB 2013.

NIFTY

Nifty has strong support near 5820-5830 levels. If manages to hold onto it, can bounce back to 5920-5950. On the downside if breaks 5820 can test 5730-5750.

ICICI BANK 

ICICI Bank has strong support near 1100 levels. If closes below 1100 levels, can see 1060. On the upside has strong resistance at 1140-1160 levels.

INFOSYS

Infosys has been moving in a small range of 2750-2820 recently. Has strong resistance at 2820 levels. Once manages to cross it, can head upto 2900 levels. On the downside below 2750 can test 2700.

 

MARKET OUTLOOK FOR 20th February 2013

Daily trend of the market is down

Market is taking a counterrally but till the overall trend remains down the readers may not create long positions and stay out of the market.

Percentage above support

Percentage of stocks above support is still below 50%, so the readers may not create long positions in cash market till the percentage above support remains below 50%.

Strong Futures

This is list of 10 Strong Futures: Sun Pharma, Mcleodruss, NHPC, TCS, Tech M, DLF, Adani Ports, HCL Tech, ONGC & Infyl.

Weak Futures

This is list of 10 Weak Futures: Opto Circuits, HDIL, Adani Power, Finan Tech, IVRCL Infra, Jindal Steel, unitech, LIC Hsg, Siemens & Rel Capital.

MARKET OUTLOOK for 12th Feb 2013.

Daily trend of the market is down

Market is still continuing its downward movement and its first support is nearby from where a small counter rally is expected. But as overall trend of the market is still down, so the readers may stay out of the market and wait for it to come in uptrend.

Percentage above support

Percentage of stocks above support is still below 50%, so the readers may not create long positions in cash market till the percentage above support remains below 50%.

Strong Futures

This is list of 10 Strong Futures: Suzlon, Adani Ports, NHPC, TCS, PFC, DLF, Havells, Axis Bank, Zeel & MC Dowell.

Weak Futures

This is list of 10 Weak Futures: Opto Circuits, HDIL, JP Associat, Jain Irrigation, UCO Bank, Guj Fluoro, KTK Bank, ALBK, Finan Tech & JP Power.

MARKET OUTLOOK FOR 11th Feb 2013

Daily trend of the market is down

As the Market has becomes somewhat oversold so might consolidate at current level and may also give a small counter rally from here. But as overall trend of the market is down, so the readers may stay out of the market and wait for it to come in uptrend.

 Percentage above support

Percentage of stocks above support is still below 50%, so the readers may not create long positions in cash market till the percentage above support remains below 50%.

Strong Futures

This is list of 10 Strong Futures: Suzlon, PFC, Adani Ports, NHPC, Zeel, DLF, Sun TV, Infy, Yes Bank & MC Dowell.

Weak Futures

This is list of 10 Weak Futures: Opto Circuits, HDIL, IVRCL Infra, JP Associat, Jain Irrigation, UCO Bank, ALBK, Guj Fluoro, KTK Bank & JP Power.

HOW TO START A CHARITY

Many people feel the urge to help out by volunteering time or income. For those whose charitable itch cannot be scratched via conventional methods, there is the possibility of operating your very own charitable foundation. It should be noted that this requires a substantial investment of time and money. It is therefore not an endeavor to be taken lightly, but for those fueled by a zeal to help their chosen causes, creating a charity can be the best way to make a difference.

Money
 

The first serious consideration is money. Expect to be working for free or for a considerable pay cut during the initial phases of your charity. It is not unusual to have to live off savings for periods of a year or more.

Additionally, even after many years of successful operation, salaries at non-profits can be quite a bit lower than in the private sector. This is less true for the largest organizations, but the general trend is that the cause comes first, so be sure you are financially prepared. Time is also a factor to be considered. Starting and operating a charity is time-consuming. Anticipate long hours devoted to the various functions of supporting the charity. If you are still reading, it is likely you are comfortable with the time and financial commitments required and have the drive to achieve success. In fact, you probably already have a cause in mind.

Vision
 

Your next step then should be to craft a vision statement. This is your idea of what you hope the charity will accomplish. What inspired you to create this charity, and what do you see it achieving into the future? It is appropriate to be somewhat vague because this is just a broad overview and introduction to your cause. The mission statement is where you break down the specifics of: whom the charity is benefiting, what exactly you will be doing and how this is going to achieve your vision.

Choosing a Name
 

At this stage a name should be chosen. Choose a name that people can relate to. It should be something personal, memorable, and something that will support your brand and vision. This is especially important because a properly chosen name can help differentiate your charity from the 1.5 million other non-profit organizations in the United States. Getting noticed gets donations. You are now ready to get down to business. Establish a five-year plan of operations. Decide who is going to do what and how it will be done. A useful suggestion for before commencement of operations is to have enough cash for the initial capital outlay in addition to a year's worth of operating funds.

Get Funding
 

You should also decide on a funding source. Most charities raise funds through private donations or seek out government and foundational grants. Worth looking into is the concept of "social entrepreneurism" where instead of going to traditional fundraising sources, as above, a charity instead sells a product or service with the proceeds going to the charitable cause.

Office Space
 

A physical workplace may or may not be useful for you. Rent can rapidly increase overhead, but donors and governments prefer numbered addresses instead of P.O. boxes. In the early stages, there is really no reason your home would not suffice as a base of operations.

Get a Lawyer and an Accountant
 

You should also get a lawyer and an accountant who are both well versed in advising non-profit organizations. They will assist with drafting articles of incorporation required to register your charity with your state. In addition, they will be useful in registering with the IRS.

Register and Get a Board of Directors
 

Finally, register with your attorney general in order to be allowed to solicit donations. Finally, serious consideration should be given to the composition of the board that manages the charity. While often overlooked, having a solid board of directors will help to keep your goals in focus and prevent any unfortunate legal ramifications. The size of the board will vary with need, but be sure to constantly evaluate its performance and seek out those with experience running non-profits.

The Bottom Line
 

Starting a charity requires an immense dedication of time, passion for a cause, and business savvy. You may be setting out to fund an altruistic organization, but good intentions won't pay your bills, so be sure you're financially prepared to live on a small income for a long period of time.

THINK LIKE WARREN BUFFETT

Back in 1999, Robert G. Hagstrom wrote a book about the legendary investor Warren Buffett, entitled "The Warren Buffett Portfolio". What's so great about the book, and what makes it different from the countless other books and articles written about the "Oracle of Omaha" is that it offers the reader valuable insight into how Buffett actually thinks about investments. In other words, the book delves into the psychological mindset that has made Buffett so fabulously wealthy. (For more on Warren Buffett and his current holdings, check out Coattail Investor.)

Although investors could benefit from reading the entire book, we've selected a bite-sized sampling of the tips and suggestions regarding the investor mindset and ways that an investor can improve their stock selection that will help you get inside Buffett's head.

1. Think of Stocks as a Business
 

Many investors think of stocks and the stock market in general as nothing more than little pieces of paper being traded back and forth among investors, which might help prevent investors from becoming too emotional over a given position but it doesn't necessarily allow them to make the best possible investment decisions.

That's why Buffett has stated he believes stockholders should think of themselves as "part owners" of the business in which they are investing. By thinking that way, both Hagstrom and Buffett argue that investors will tend to avoid making off-the-cuff investment decisions, and become more focused on the longer term. Furthermore, longer-term "owners" also tend to analyze situations in greater detail and then put a great eal of thought into buy and sell decisions. Hagstrom says this increased thought and analysis tends to lead to improved investment returns. (To read more about Buffett's ideologies, check out Warren Buffett: How He Does It and What Is Warren Buffett's Investing Style?)

2. Increase the Size of Your Investment
 

While it rarely - if ever - makes sense for investors to "put all of their eggs in one basket," putting all your eggs in too many baskets may not be a good thing either. Buffett contends that over-diversification can hamper returns as much as a lack of diversification. That's why he doesn't invest in mutual funds. It's also why he prefers to make significant investments in just a handful of companies. (To learn more about diversification, read Introduction To Diversification, The Importance Of Diversification and The Dangers Of Over-Diversification.)

Buffett is a firm believer that an investor must first do his or her homework before investing in any security. But after that due diligence process is completed, an investor should feel comfortable enough to dedicate a sizable portion of assets to that stock. They should also feel comfortable in winnowing down their overall investment portfolio to a handful of good companies with excellent growth prospects.

Buffett's stance on taking time to properly allocate your funds is furthered with his comment that it's not just about the best company, but how you feel about the company. If the best business you own presents the least financial risk and has the most favorable long-term prospects, why would you put money into your 20th favorite business rather than add money to the top choices?

3. Reduce Portfolio Turnover
 

Rapidly trading in and out of stocks can potentially make an individual a lot of money, but according to Buffett this trader is actually hampering his or her investment returns. That's because portfolio turnover increases the amount of taxes that must be paid on capital gains and boosts the total amount of commission dollars that must be paid in a given year.

The "Oracle" contends that what makes sense in business also makes sense in stocks: An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business.

Investors must think long term. By having that mindset, they can avoid paying huge commission fees and lofty short-term capital gains taxes. They'll also be more apt to ride out any short-term fluctuations in the business, and to ultimately reap the rewards of increased earnings and/or dividends over time.

4. Develop Alternative Benchmarks
 

While stock prices may be the ultimate barometer of the success or failure of a given investment choice, Buffett does not focus on this metric. Instead, he analyzes and pores over the underlying economics of a given business or group of businesses. If a company is doing what it takes to grow itself on a profitable basis, then the share price will ultimately take care of itself.

Successful investors must look at the companies they own and study their true earnings potential. If the fundamentals are solid and the company is enhancing shareholder value by generating consistent bottom-line growth, the share price, in the long term, should reflect that. (To learn how to judge fundamentals on your own, see What Are Fundamentals?)

5. Learn to Think in Probabilities
 

Bridge is a card game in which the most successful players are able to judge mathematical probabilities to beat their opponents. Perhaps not surprisingly, Buffett loves and actively plays the game, and he takes the strategies beyond the game into the investing world.

Buffett suggests that investors focus on the economics of the companies they own (in other words the underlying businesses), and then try to weigh the probability that certain events will or will not transpire, much like a Bridge player checking the probabilities of his opponents' hands. He adds that by focusing on the economic aspect of the equation and not the stock price, an investor will be more accurate in his or her ability to judge probability.

Thinking in probabilities has its advantages. For example, an investor that ponders the probability that a company will report a certain rate of earnings growth over a period of five or 10 years is much more apt to ride out short-term fluctuations in the share price. By extension, this means that his investment returns are likely to be superior and that he will also realize fewer transaction and/or capital gains costs.

6. Recognize the Psychological Aspects of Investing
 

Very simply, this means that individuals must understand that there is a psychological mindset that the successful investor tends to have. More specifically, the successful investor will focus on probabilities and economic issues and let decisions be ruled by rational, as opposed to emotional, thinking.

More than anything, investors' own emotions can be their worst enemy. Buffett contends that the key to overcoming emotions is being able to "retain your belief in the real fundamentals of the business and to not get too concerned about the stock market."

Investors should realize that there is a certain psychological mindset that they should have if they want to be successful and try to implement that mindset. (To learn more about investor behaviors, read Understanding Investor Behavior, When Fear And Greed Take Over and Master Your Trading Mindtraps.)

7. Ignore Market Forecasts
 

There is an old saying that the Dow "climbs a wall of worry". In other words, in spite of the negativity in the marketplace, and those who perpetually contend that a recession is "just around the corner", the markets have fared quite well over time. Therefore, doomsayers should be ignored.

On the other side of the coin, there are just as many eternal optimists who argue that the stock market is headed perpetually higher. These should be ignored as well.

In all this confusion, Buffett suggests that investors should focus their efforts of isolating and investing in shares that are not currently being accurately valued by the market. The logic here is that as the stock market begins to realize the company's intrinsic value (through higher prices and greater demand), the investor will stand to make a lot of money.

8. Wait for the Fat Pitch
 

Hagstrom's book uses the model of legendary baseball player Ted Williams as an example of a wise investor. Williams would wait for a specific pitch (in an area of the plate where he knew he had a high probability of making contact with the ball) before swinging. It is said that this discipline enabled Williams to have a higher lifetime batting average than the average player.

Buffett, in the same way, suggests that all investors act as if they owned a lifetime decision card with only 20 investment choice punches in it. The logic is that this should prevent them from making mediocre investment choices and hopefully, by extension, enhance the overall returns of their respective portfolios.

Bottom Line
 

"The Warren Buffett Portfolio" is a timeless book that offers valuable insight into the psychological mindset of the legendary investor Warren Buffett. Of course, if learning how to invest like Warren Buffett were as easy as reading a book, everyone would be rich! But if you take that time and effort to implement some of Buffett's proven strategies, you could be on your way to better stock selection and greater returns.