The one question you should always ask when investing

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“WHY do I want to buy what they want to sell?”

Whether youre buying stocks, bonds, property or funds, its the fundamental question behind any investment. And if youre not sure of the answer, its worth bearing in mind the old gamblers maxim.

If you dont know who is the patsy in the room, it is probably you, Financial Times columnist John Kay writes in his new book, The Long and The Short of It.

Subtitled A Guide to Finance and Investment for Normally Intelligent People who Arent in the Industry, Kays book is a comprehensive and straightforward guide to the increasingly complex world of modern finance.

Kay, a Visiting Fellow at the London School of Economics and a Fellow of St Johns College, Oxford, starts out with the basics of investment and financial markets, before progressing to more modern developments such as derivatives and hedge funds.

Touching on themes like market psychology, irrationality and bubbles, Kay progresses to a blueprint for intelligent investing and offers practical tips on how to implement a strategy. For mum-and-dad retail investors, Kay advocates a contrarian approach.

Some of the biggest mistakes in my own investment history have been following the crowd when the crowd was going in the right direction for example, buying European property in 2006, when the mind of the market identified it as an undervalued asset class.

Even if the crowd is right about fundamental value (and in that case I think it was), the fashion is in the price. When the fashion fades, so will some of the money you have paid (and within two years, it had).

Kay notes that there is something paradoxical in the idea that the best way to use the expertise of the financial services industry is to do the opposite of what it recommends.

He concludes the book with the original question. Both buyers and sellers own securities in the hope of income and capital gains. But the returns the buyer will obtain are exactly the returns the seller could have obtained, he writes.

Why should you buy what they want to sell?

In any kind of market, where there is wide and unresolvable uncertainty or in which participants have different information or beliefs, many trades will be the result of mistakes. In financial markets, uncertainty and differential information are endemic, he writes. When you trade, you need to be confident that it is not you who is making the mistake.

How do you do that? Keep it simple.

If you dont understand a financial product, dont buy it, Kay writes. We purchase cars and computers and many other things without understanding how they work it is enough to understand their purpose. We rely on the reputation of Mercedes or Microsoft for our belief that their products will actually deliver what they promise.

Modern financial markets are complex, but much of the complexity is for the benefit of providers, rather than consumers, of financial services. If you dont understand it, dont do it.

That simple maxim would have saved both amateurs and professionals billions of pounds over the years, and the more recent the years, the larger the savings.

The Long and the Short of It: A Guide to Finance and Investment for Normally Intelligent People who Arent in the Industry by John Kay, published by Allen & Unwin, is available in stores now, $24.99.

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