Recently, I read this book about financial freedom. I think it is one of the books that should be read on this path. It explains in detail how to achieve financial freedom with a simple and clear narrative.
There is also a short section on investing. The authors emphasized that this investment section is included only to establish a basic logic. In other words, this book is not sufficient to learn about investing. However, one part, in my opinion, explains very well the necessity of having a system for investing.I wanted to share my thoughts on this section.
I’m leaving the original quote below:
“The best way to avoid behavioral mistakes is to develop systems, remove yourself and your emotions, and allow the process to do the work for you. Part of the process of being a passive investor is acknowledging that the road is bumpy, and you will be subject to some luck, accepting those facts, and then proceeding anyway.
The best way to accomplish this is to focus on things you can control, particularly earning more and spending less to develop a higher savings rate.
When the market goes up, your invested money will grow. When the market dips, new money you invest will go toward buying more shares. No matter what the market is doing, you’ll be progressing toward FI.”
Some Key Points to Highlight
First and foremost, a system free from emotions and personal character is really important. This saves us from panicking when prices fall and making mistakes like getting caught up in trends and buying shares at their peak.
What Does Being Systematic Mean?
It’s possible to observe significant mistakes being made in stock market investments. People can suffer huge losses by investing in stocks they hear about from here and there, thinking that newly public companies are guaranteed sources of returns, or jumping on the bandwagon of rising stocks at the last moment with FOMO (fear of missing out). The root causes of these are ignorance and the lack of a system.
Not everyone needs to be highly financially literate. Not everyone needs to know how to analyze stocks and balance sheets. But everyone must have an investment system. Otherwise, there is no difference between investing and gambling.
It is impossible to know where a stock or the market will go—not “nearly impossible,” but completely impossible. For this reason, we cannot control this part. However, we can control how much money we allocate for investment each month. For example, instead of buying another piece of clothing, we can allocate this money for investment. Therefore, investing money into a stock fund, regardless of the market’s direction, can be a system. You don’t need to be a stockbroker to do this. Simply, being consistent will suffice. When you invest regularly every month, if the market goes up, your money grows, and if it goes down, you buy more shares with the amount you invest, and you will be happy in both cases. When shoes go on sale, we don’t hesitate to buy them, but when stock prices fall, we panic. Here, we can think of a good company as just being “on sale.”
In reality, the topic is very simple: almost everyone can manage to regularly allocate some money from their income and invest it systematically into a stock fund. In this way, it becomes possible to watch our investments grow in the long term, independent of price fluctuations.
My Personal Investment System
Now, I’d like to talk a bit about how I apply this myself. I prefer investing in the U.S. stock market rather than the Turkish market. This is a personal preference. Even though there are very good Turkish companies, I haven’t come across a stock that fits the system I describe below.
I am not a financial analyst, but I can say that I’ve read most of the essential books on investing. Based on the information I’ve gathered from these books, I’ve created an investment system.
The Core of My System
Essentially, I have two methods:
- Index Funds or ETFs:
I aim to keep about 50–60% of my investment size in S&P 500 ETFs. The reason is that I believe these funds are safer. This can actually be defined as believing in the long-term success of American companies or the economy. I think the potential for upward movement is higher than the potential for decline. To reiterate, I am not a financial analyst. Therefore, I don’t have enough time or expertise to select individual companies, and investing all my money in individual companies doesn’t align with my risk perception. - Individual Stocks:
However, I also enjoy investing in individual companies. I follow a system for this, as mentioned earlier. Over time, I’ve built a checklist that I continuously update by adding new criteria. I evaluate the performance of each company based on this list.
The list is below with the threshold for each criteria. All of them are stuff I can gather by looking at a company’s financials.
Here are some examples from my list:
- Gross Margin:
I require this to be at least 40%. This is a non-negotiable criterion because, according to general opinion, companies with this margin are believed to have stronger product/service structures and stand out from competitors.
- Free Cash Flow (FCF):
This measures how much of the cash generated from operations a company can retain for discretionary use. I want this to be at least 5%. The higher this percentage, the better.
Companies that meet most of the criteria on my list are ones I consider good. While some criteria are non-negotiable, I may slightly expand others when selecting companies.
Valuation Methods
After identifying good companies, the next step is valuation. Paying a high price for a stock, even for a great company, can lead to losses. I evaluate valuation using two main methods:
- Price-to-Earnings (P/E) Ratio:
The P/E ratio helps investors determine if a stock is overvalued or undervalued compared to its earnings potential and industry peers.
If the P/E ratio has been in a downward trend over the past five years, I assume the stock is undervalued. Although this is not a very strong indicator, it serves as a directional guide.
- Discounted Cash Flow (DCF) Analysis:
This involves predicting the future earnings of a company and calculating its present value to determine a stock price. If the current stock price is below this calculated value, the stock is undervalued.
For DCF analysis, I use a tool called Simply Wall Street, which provides free access to data for up to five companies per month. It includes DCF analysis based on analysts’ average forecasts and their one-year price predictions. I use these predictions to estimate where the stock price will be in the short and long term.
Additionally, as Warren Buffett suggests, I ensure a margin of safety. This is like insurance for mistakes on estimations. For widely analyzed stocks (like Google or Tesla), I require the price to be at least 20% below the calculated value. For lesser-known stocks, I require at least a 50% discount.
Final Thoughts
Investing in individual stocks without sufficient knowledge and confidence is highly risky. However, not investing at all is not an option. Index funds or ETFs provide a valid and effective system. You can choose ETFs or funds on different industries such as solar panels or computer chips, or you can prefer to invest in the stock market in general using S&P 500 or Nasdaq indices. Pick you method and keep investing in it regardless of market direction and you will be fine. By investing consistently in funds and not panicking during downturns, it is possible to see an unexpectedly large portfolio after 10–15 years.
Let’s not forget, stock market investment is full of ups and downs. The most important points are:
- Not panicking and continuing regular investments.
- Avoiding investing money you’ll need in the short term.
- Not trying to invest using borrowed money.
By following these rules, our chances of success increase significantly. Investing is a long-term marathon, not a shortcut to wealth. As the time horizon extends, so does the likelihood of success.
References:
- Faircloth, Chris, and Jonathan Mendonsa. Choose FI: Your Blueprint to Financial Independence. The Experiment, 2019.
The Monk of Abundance 