Investment rules are a tool that I use to minimize my investing mistakes. Properly utilized, investment rules can act as a check valve on bad decision making and help you to improve your investing process over time.
I plan to update this page over time as a useful public reference for my personal investment rules. I hope that they will be useful as a public resource to help others improve their investing process. In addition, it is my goal to use this page as a living checklist when I make investing decisions.
Two Types of Investment Rules: Hard and Soft
My investment rules will be categorized into two different types: hard rules and soft rules.
The difference should be quite clear.
Hard rules are mandatory. They should not be broken because they directly protect me from an investing mistake. Hard rules might specifically prohibit certain types of investments or limit my investment universe in some way.
Soft rules are guidelines, recommendations, or warnings. Soft rules don’t directly prohibit any specific investment or limit your investing universe. Instead, a soft rule will provide you with guidance on how to select between similar investments. Soft investment rules deal in the realm of preferences and priorities.
Hard Investment Rules:
Investment Rule #1: Never buy a retail company with declining revenue
- Retail companies have high operating leverage.
- It is difficult to accurately understand your margin of safety when investing in a retail company.
- A small decline in revenues can disproportionately erode a retail firm’s owner’s earnings.
- Origin: GameStop stock investment post-mortem
Investment Rule #2: Never buy a physical retail company with debt on its balance sheet (if they lease their locations)
- While all physical retail companies have operating leverage, additional leverage is unnecessary.
- Debt creates an additional layer of leverage, increasing the risk for shareholders.
- Balance sheet debt is only acceptable if used to replace operating leases with mortgages. Such an arrangement might actually lower risk.
- Origin: GameStop stock investment post-mortem
Investment Rule #3: Do not hold onto a stock once you know your investment thesis is wrong
- This investment rule is simply an application of the mental model: “Zero Based Thinking”
- We use a Buy Thesis before we purchase stocks to explain why we are making our investments. If the reason you bought a stock no longer exists, then you also shouldn’t continue to own the stock.
- Origin: GameStop stock investment post-mortem
Soft Investment Rules:
Investment Rule #1: Prioritize investing in companies where management has Skin in the Game
- This investment rule is simply an application of the mental model: “Skin in the Game” popularized by Nassim Taleb.
- Skin in the game goes well beyond simple incentives. Stock options do not create skin in the game.
- Look for management with a large percentage of their net worth invested in company stock.
- A positive sign is when management earns more from annual dividends than their company salary.
- Founder CEOs are preferred.
- Origin: GameStop stock investment post-mortem
Investing Disclaimer
All investments involve risks and any investment can result in a complete loss of capital. ALWAYS do your own research prior to purchasing an investment. I am NOT a financial advisor. I am NOT a registered investment advisor and I do NOT provide investment advice. None of the rewards, research, or other benefits from being a member/patron of DIY Investing’s membership site should be construed as investment advice. I have NOT taken into account your personal financial situation in developing this content. I shall NOT be held liable for any errors or omissions in the content provided on this website. All content is provided for informational and educational purposes only. I, Trey Henninger, and DIYInvesting.org shall NOT be held liable for any investment decisions made from the use of the content provided via the DIYInvesting.org website. Read my full Terms of Service for additional information.
