These three simple rules of investing can help you keep the right mindset when you run into uncertainty. Of course, they’re a bit limited in scope, so if you’re looking for a more robust rule set, check out 10 Basic Rules of Investing According to the Legends, or Benjamin Graham’s Seven Criteria for Picking Value Stocks for more detailed guidelines.
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3 Simple Rules of Investing to Follow Now
There are, of course, many approaches to investing. You can look at technical analysis, or different ratios, or stick to dividend stocks, or just hand all your cash over to a broker and hope for the best (although we’re big proponents of investing on your own). You can follow rules that focus on growth investing, or short selling, or options trading.
But when it comes down to it, there are three simple rules of investing that almost every investor should keep in mind. The first two come from Warren Buffett. The third is our own.
- Rule #1: Don’t lose money.
- Rule #2: Don’t forget Rule #1.
- Rule #3: Let your winners run.
These rules are simple, but they aren’t necessarily easy to follow. Here’s what they look like in practice.
Rule #1: Don’t Lose Money
One of the easiest ways to make money in the stock market is to buy stocks when the broader market is going up. It’s easier to swim with the tide than against it, and investing is no different.
When the market is healthy, investors generally have more opportunities to make money. When the market is deteriorating, it makes sense to become more defensive, weed out weak positions and raise cash when necessary.
That doesn’t mean you should try to predict every market move. It does mean you should pay attention to the environment you’re investing in and avoid taking unnecessary risks when the odds are moving against you.
Rule #2: Don’t Forget Rule #1
Protecting your capital also means cutting losses before they can do real damage.
When a stock starts falling, the theoretical downside is zero. And the longer you hold a losing position, the more capital you have tied up in an investment that may no longer deserve it.
If the reasons you bought a stock no longer hold true—whether they were based on fundamentals, technical action, dividend yield or something else—you should consider selling.
A modest loss is usually much easier to recover from than a large one.
At the same time, don’t confuse normal volatility with a reason to sell. One of the hardest things for investors to do is nothing. If an investment is behaving as expected and hasn’t violated the rules or criteria that got you into it, sometimes sitting on your hands is the smartest move you can make.
The goal isn’t to react to every wiggle in a stock’s price. It’s to recognize when your original thesis has broken down and act before a manageable loss becomes a serious one.
Rule #3: Let Your Winners Run
Just as investors can hurt themselves by holding losers too long, they can also hurt themselves by selling winners too soon.
The power of compound growth can dramatically increase the value of your portfolio over time—but only if you give successful investments enough time to work.
Big gains rarely happen overnight. They often come from owning strong companies through multiple periods of growth and resisting the temptation to take a quick profit simply because a stock is up 10% or 20%.
If a stock continues to perform well and the reasons you bought it remain intact, consider giving it room to keep climbing.
Some of the biggest portfolio gains come from stocks that rise 100%, 200% or more over time. Those kinds of returns can have an outsized impact on your overall results and can more than make up for several small losses elsewhere.
That doesn’t mean you should never take profits. If one winning position becomes an unusually large percentage of your portfolio, taking partial profits can be a sensible way to manage risk.
But don’t automatically sell a great stock simply because it has gone up.
Cut your losers when the evidence tells you you’re wrong. Be patient when nothing has changed. And when you find a true winner, give it the opportunity to become a much bigger one.
Protect your capital, stay disciplined, and let your winners run.
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*This post has been updated from a previously published version.