It can be hard to pass on money advice to the next generation. After all, things change and the whole world is a different place in 30 or 40 years than it is today. Here are three lessons on money, however, that may prove relevant at this time and beyond.
Do not walk with the herd
No matter what asset it is and no matter what the prospects are, it’s important not to run with the herd. This means that when the demand for an asset is high and its valuation has risen dramatically, that is usually the worst time to buy. Because a rosy future has already been priced in. Should this expectation be disappointed, the value could fall dramatically.
An example of such a case is the dot-com bubble. Technology stocks were highly rated due to the enthusiasm of Internet-age investors. Although the Internet has changed all our lives, it has perhaps been less drastic and slower change tan previously expected. As a result, these technology stocks, which appreciated in value around the turn of the millennium, proved to be a bad investment.
Similarly, it may be a bad decision to sell shares if the outlook is considered pessimistic. The credit crisis is a prime example of this. The global stock markets fell in 2008 and 2008, before rebounding significantly in the following years. However, many investors missed this increase because the general feeling in the investment community was one of fear.
Do not just concentrate on profitability
For many investors, the key focus is on a company’s profitability. While this is undoubtedly important, in reality more is behind a company’s financial health than just profitability.
For example, the balance sheet strength of a company has a major impact on its long-term earnings. If it has a high level of debt, then the profits can be enormous, but most of it may eventually be used for interest payments. Similarly, a weak cash flow that pays too generous a dividend or has burdensome investment commitments could jeopardize a company’s long-term viability.
By focusing on a company’s financial performance as a whole rather than profitability, an investor can better assess their overall risk profile. That should increase portfolio returns in the long term.
Find a competitive advantage
For the most part, the companies that stay in the long run have a competitive advantage over their peers. For example, in the extractive industry this could be on a lower cost basis or in high customer loyalty, which has allowed them to enforce higher prices on the market than their competitors.
Both examples mean that the company in question has a better chance of surviving difficult times within the industry. They also mean that the profitability of these companies in the boom years is higher, which can lead to an improved share price performance.
The simple secret to buy the best stocks
As Warren Buffett once said, you do not have to have a genius IQ to be a great investor. All you need is simple math, knowing what numbers to look at, and some common sense.
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