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When Should we Hold Back From Buying Stocks?

Investing in stocks is a great way to grow your assets over the long term. In fact, one of the mantras that I believe we should all follow is that we should “buy good stocks, consistently, for the long term”. Very rarely, however, do we talk about when not to buy stocks. Personally, I think this subject is equally important and investors should develop some mental models to help them.

In this article, I’ll look at a number of situations when investors should hold back from buying stocks.

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When you don’t understand the business                            

One of the most important rules in buying stocks is always buying things that you know. In other words, you should have a reasonably strong understanding of the investments before you put money into it.

For example, before buying one of the big three Singapore banks, you should at least know how each bank makes money (providing various financial services), where it makes the majority of its money (Singapore and other countries like China, Hong Kong, India etc), the company’s dividend policy, track records and more.

As an investor, you should know what you invest in and not buy just because somebody gave you a tip or you read some article in the newspaper talking about certain companies getting new projects or deals, for example. And what if you just don’t know what to buy? Perhaps you don’t have the necessary time to carry out your research? Well, just put your cash into whatever you know – such as a fixed deposit. After all, getting 1-2% interest is better than risking your hard-earned cash in something that you don’t know.

When absolutely everybody is making money in stocks

Though the stock market grows over time (mainly as a result of economic growth) and rewards patient investors, a lot of short-term profits generated in the stock market are mainly a result of a zero-sum game. In other words, one man’s profit is another man’s loss. As such, in “normal” times, there will be a balance between winners and losers.

Now, when everybody starts making money no matter what stocks they buy, and company fundamentals are ignored, then something unusual is going on in the market. Such is the time that new “investors” find all the best reasons to be in the stock market. This is natural since the belief in the market during these times of euphoria is that it’s so “easy” to make money.

Usually, this is the time that serious investors should really be cautious and exercise scepticism. In fact, this might be the time to actually avoid buying stocks altogether, or even selling some stocks. Though such a decision might cost investors some foregone profits (which could be huge during a bubble), it could also preserve their capital in the long run. After all, Warren Buffet famously quoted that “rule number one is never lose money, and rule number two is never forget rule number one”.

Conclusion

In sum, investing in the stock market is about what to do, and also what not to do. Similarly, there are times we should buy aggressively yet other times where we should avoid buying altogether. But is this the time to buy or avoid stocks? That’s a judgment that each investor must make for themselves.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Lawrence Nga doesn’t own shares in any companies mentioned.