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There are 10 basic investment rules that have historically kept investors out of trouble over the long
term. These are not unique by any means but rather a list of investment rules that in some shape, or form, has been uttered by every great investor in history.
The original article has been edited here for length (…) and clarity ([ ])
1) You are a speculator – not an investor
Unlike Warren Buffet who takes control of a company and can affect its financial direction – you can only speculate on the future price someone is willing to pay you for the pieces of paper you own today. Like any professional gambler – the secret to long-term success was best sung by Kenny Rogers; “You gotta know when to hold’em…know when to fold’em”.
2) Asset allocation is the key to winning the “long game”
In today’s highly correlated world there is little diversification between equity classes. Therefore, including other asset classes, like fixed income which provides a return of capital function with an income stream, can reduce portfolio volatility. Lower volatility portfolios outperform over the long term by reducing the emotional mistakes caused by large portfolio swings.
3) You can’t “buy low” if you don’t “sell high”
Most investors do fairly well at “buying,” but stink at “selling.” The reason is purely emotional, which is driven primarily by “greed” and “fear.” Like pruning and weeding a garden; a solid discipline of regularly taking profits, selling laggards and rebalancing the allocation leads to a healthier portfolio over time.
4) No investment discipline works all the time – Sticking to a discipline works always.
Like everything in life, investment styles cycle. There are times when growth outperforms value, or international is the place to be, but then it changes. The problem is that by the time investors realize what is working they are late rotating into it. This is why the truly great investors stick to their discipline in good times and bad. Over the long term – sticking to what you know, and understand, will perform better than continually jumping from the “frying pan into the fire.”
5) Losing capital is destructive. Missing an opportunity is not.
As any good poker player knows – once you run out of chips you are out of the game. This is why knowing both “when” and “how much” to bet is critical to winning the game. The problem for most investors is that they are consistently betting “all in all of the time” as they maintain an unhealthy level of the “fear of missing out.”…
6) Your most valuable, and irreplaceable, commodity is “time.”
Since the turn of the century investors have recovered, theoretically, from two massive bear market corrections. It took 14- years for investors to get back to where they were in 2000 on an inflation-adjusted total return basis. Furthermore, despite the bullish advance from the 2009 lows, the compounded annual total return for the last 18-years remains below 3%.
The problem is that the one commodity which has been lost, and can never be recovered, is “time.” For investors getting back to even is not an investment strategy. We are all “savers” that have a limited amount of time within which to save money for our retirement…Do not discount the value of “time” in your investment strategy.
7) Don’t mistake a “cyclical trend” as an “infinite direction”
There is an old Wall Street axiom that says the “trend is your friend.”…[The problem, however, is that] investors always tend to extrapolate the current trend into infinity…
It is important to remember that the “trend is your friend” as long as you are paying attention to, and respecting, its direction. Get on the wrong side of the trend and it can become your worst enemy.
8) If you think you have it figured out – sell everything.
…Every day individuals pile into one of the most complicated games on the planet with their hard earned savings with little, or no, education at all.
For most individuals, when the markets are rising, their success breeds confidence. The longer the market rises; the more individuals attribute their success to their own skill. The reality is that a rising market covers up the multitude of investment mistakes that individuals make by taking on excessive risk, poor asset selection or weak management skills. These errors are revealed by the forthcoming correction.
9) Being a contrarian is tough, lonely and generally right.
…The best investments are generally made when going against the herd. Selling to the “greedy” and buying from the “fearful” are extremely difficult things to do without a very strong investment discipline, management protocol, and intestinal fortitude. For most investors, the reality is that they are inundated by “media chatter” which keeps them from making logical and intelligent investment decisions regarding their money which, unfortunately, leads to bad outcomes.
10) Benchmarking performance only benefits Wall Street
The best thing you can do for your portfolio is to quit benchmarking it against a random market index that has absolutely nothing to do with your goals, risk tolerance or time horizon…The only benchmark that matters to you is the annual return that is specifically required to obtain your retirement goal in the future. If that rate is 4% then trying to obtain 6% more than doubles the risk you have to take to achieve that return. The end result is that by taking on more risk than is necessary will put your further away from your goal than you intended when something inevitably goes wrong.
It’s all about the risk.
Most people are in denial about uncertainty. They assume they’re lucky, and that the unpredictable can be reliably forecasted. This keeps business brisk for palm readers, psychics, and stockbrokers, but it’s a terrible way to deal with uncertainty.
It should be obvious that an honest assessment of uncertainty leads to better decisions. It may seem contradictory, embracing uncertainty reduces risk while denial increases it. Another benefit of “acknowledged uncertainty” is it keeps you honest. A healthy respect for uncertainty, and a focus on probability, drives you never to be satisfied with your conclusions. It keeps you moving forward to seek out more information, to question conventional thinking and to continually refine your judgments and understanding that difference between certainty and likelihood can make all the difference.
The reality is that we can’t control outcomes; the most we can do is influence the probability of certain outcomes which is why the day to day management of risks and investing based on probabilities, rather than possibilities, is important not only to capital preservation but to investment success over time.
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I’ve always said that personal finances are more important than portfolio management, but I still think there’s probably not enough people writing or providing education on the topic so I’m going to make a concerted effort to write more about personal finance in the coming year and, to that end, here’s my list of 20 personal finance rules:
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Investment “rules” that were relevant for a century are obsolete. They were based on a world where economies grew, people’s standard of living increased and outcomes tomorrow better than today. Arguably each of these conditions will not hold in the future but if they don’t, neither do the rules of thumb that guided investing last century. These guiding principles developed and worked in a world that that no longer exists but applying them in the future will result in devastating financial outcomes. [Let me explain.]
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