Foolish Rules For Good Investing

This is part five of our personal finance GCSE course. Here you'll read how to make money using some of the key Foolish investment philosophies and rules.

This is part five of The Motley Fool's Personal Finance GCSE. Previously: 1. Read how to get out of debt in The Motley Fool's Personal Finance GCSE! 2. Read how to get into debt in A Complete Guide To Borrowing Money 3. Read about the two most Foolish ways to save money in Two Of The Seven Best Ways To Save Money 4. Read about your five next best choices for savings in Five More Places To Put Your Savings Now you're out of debt and saving money, we'll tell you how to make more money. This part will run through the most Foolish ideas for investing, which is where The Motley Fool all began. Fund managers Some years ago we released a bestselling book called The Motley Fool UK Investment Guide. It tells you in extraordinary detail how to carry out cardiac surgery in your garage with a pair of shears and a pack of frozen peas. It also tells you how to be your own fund manager. While the authors (Dr. David Berger, co-founder of Fool UK and a GP, and Jimmy Carlisle, a former Foolish investment writer) admit that you will be doing well as an amateur cardiac physician to outperform a professional, they are confident that you can achieve this level of expertise against a fund manager. And rightly so. I once had a chat with an asset manager from one of the world's largest investment banks. In his office, he sat right next to the fund managers who invested in shares. He told me that they were all average people that he wouldn't trust with his money. Yet to use the services of these managers you'll pay a fortune in initial costs and annual fees. The asset manager's comments tie in well with all my other experiences and those of my colleagues. The thing is, would you give your money to a stranger to look after? I wouldn't. Yet when you invest in a managed fund, that's precisely what you're doing. Just like many of the doctors, accountants, lawyers and other professionals you've met, lots of them are stupid or just plain rubbish. And you intend to hand over your money to one you won't ever even meet? Index trackers and exchange-traded funds The ultimately Foolish alternative is to rely on a computer instead. It sounds frightening, even to me, but it's actually very reliable and effective. It works because the computer doesn't try to do anything thing clever at all. It doesn't try to think. All it does is it buys and sells shares in all the companies of an index, such as the FTSE 100 or FTSE All Share. By doing this, your investments track the performance of the stock market. To do this you can use index trackers and exchange-traded funds (ETFs). We've written extensively about both of these at The Fool, because these non-thinking funds beat human fund managers around 80% of the time. What's more, if you can invest for ten years or longer, you can expect to build up a decent pot of money with trackers. If you want to invest in the stock market but you don't want to pick shares yourself, the following links contain probably the most important information you could possibly read: Introducing The Index TrackerIndex Trackers Vs Managed FundsChoosing An Index TrackerExchange Traded Funds For the record, I am wholly invested in trackers. If you read the above links, you'll wonder why you need do anything else. Pick shares yourself Most do-it-yourself investors have weaknesses that make them underperform the market even more than fund managers. I know some smart old guys, for example, who have picked their own shares for years. Most of them regret it now. They may have made some money, but they accept that they would have been better off tracking the market. On the other hand, stock-pickers have the potential to vastly outperform both fund managers and the market. But, before considering going for it, you had better do lots of research, be pretty smart, and know thyself. This is what you need: Brains PatienceSelf control Confidence A long-term view Lots of time to read and research shares and share strategy Focus on one strategy Don't put an over-reliance on Brains. Lots of people think, I'm smart, I can do it, but it's weaknesses in the other areas that get you. Consider: is it really worth the time? What if after thirty years you'd underperformed against index trackers? How gutted would you be about the wasted hours? Are you willing to take that risk? Most Fools who pick shares are, I believe, value investors or income investors. I am a particular fan of Fool writer Stephen Bland's income investing strategy called the high yield portfolio (HYP). I like its simplicity, consistency and its 'strategic ignorance'. It will be interesting to see if this strategy continues to be successful for the next five years, or whether it becomes so popular that it forces Stephen to move on. Read about Stephen's strategy in The High Yield Portfolio. (Note also that you can invest in high-yield shares using ETFs.) Stephen mentions strategic ignorance frequently, but here's one of his articles with a definition in it: Fish And HYPs. If you're going to go the stock-picking route, don't break the key rule: only invest in what you know and understand very well indeed. Seriously! If you see some advert about property in Bulgaria or wherever promising staggering returns, think, 'What do I know about Bulgarian property?' Absolutely nothing. So how can you assess the risks and rewards independently from the company trying to sell you something? So, as Fools often say 'DYOR'. (Do your own research.) ISAs Next, you should learn about a tax-efficient way to invest. ISA is your man. Using ISAs you can invest in trackers, individual shares or both. Read more about it in ISA Basics and Share ISAs. It's simple really. Compounding In the aforementioned Fool investment book, the authors penned some very Foolish rules. The two most important ones are 'Start early, Fool!' and 'Small differences in investment returns matter. A lot.' What they are talking about is compounding. You can read more about these two rules and how huge a difference they make in the misleadingly titled The Miracle Of Compound Returns. (Misleading because it's not a miracle, but good old reliable maths!) Property Property is a good investment too. How do you make money from it? Any good buy-to-let investor will tell you that you make money from property prices going up, and you shouldn't expect to become rich from the rental income. In fact, for the first five to ten years you can expect to lose money on your property, as your costs will often be higher than your income. The biggest downside to property investing is you can't do it from your office chair like you can with shares. In part six, the final part of this GCSE, we will talk about the crucial subject of how long you should invest for. (Well, I'll talk and you'll listen.) We'll also look at investing for retirement.