“The stock market is a giant distraction to the business of investing.” -Jack Bogle
When it comes to investing, what matters and what doesn’t? Are there timeless principles we can rely on? Of course there are. Top independent researchers have studied and verified certain principles over decades of work. Successful investors have taken advantage of the power of the principles. We have this history now. Here are those key principles:
Investment strategy supports a financial plan. Investments are not a plan. This is the most common mistake. Investments are not an answer. They don’t solve financial problems. They are not the goal.
Investment principles only work through the lens of LONG-TERM. There are constant short-term temptations. Don’t give in to these “guaranteed” products or whatever the media happens to be pushing. Long-term is hard, but rewarding. This is true in most things, but especially here.
Learn the term ASSET ALLOCATION. This is a mix of stocks, bonds, and cash. Stop getting confused by these terms. They aren’t fancy financial jargon. Stocks are owning businesses. Bonds are making loans and receiving interest. We all know cash. Historically, stocks (profits of business) have earned ~twice that of bonds (making loans). More risk means more potential for return. Less risk, less return. Asset allocation is your pie. What percentage of the 100% pie is stocks, bonds, and cash?
Properly DIVERSIFY your allocation. Within stocks/bonds, own different flavors; International, Domestic, Small, Large, Value, Growth, Real Estate, etc. Own the right combinations of these within the construct of our “pie” to feel comfortable and to support our financial plans.
REBALANCING is non-negotiable. Latest studies show maybe 1 in 4 people have auto-rebalancing in place. This is criminal, considering rebalancing may be the single most critical investment concept. What is rebalancing? When your “pie” gets out of alignment (as specific flavors ebb and flow), rebalancing gets your portfolio back in line. It’s like a tune up for your car. For example, your pie is 60% stocks 40% bonds. Stocks have an up period and now you sit at 70/30. Rebalancing would align back to 60/40. Why is it important? 70/30 is more risky, riskier than you wanted to be. Also, rebalancing systematically buys low and sells high in tiny increments. This is powerful over time.
Fund your investments consistently (or de-fund, if living off your portfolio) by time period and dollar amount. This is called dollar cost averaging. Let’s do a simple example. You are able to invest $100/month on the same day. In month one, what you are buying costs $25/unit. Your $100 buys 4 units. Month two, the cost/market drops to a price of $20/unit. Your same $100 buys 5 units. You bought more at a low price and less at a higher price. This only works if the dollar amount and time period are consistent. This is best done by setting up automatic processes with your bank and portfolio, within the framework of your plan.
Limit emotion. We can’t get rid of emotion. But, we must recognize that we are most often our own worst investment enemy. There are many studies on the destruction of acting on our emotions causes. There are studies claiming that the average investor gets only half or less of the return of their own investments. This is unbelievable and sad. They do this by panicking during low points and getting too euphoric at high market points. Don’t do either. Have a proven process and stay true to it.
Investment performance does not determine financial success. It’s measured by your financial goal plan. There is no such thing as the best performing portfolio. The “grass is greener” mindset is prevalent here. There will always be something that did better for whatever given time period. Don’t be tempted to the constant comparison of methods, time periods, what if this, what if that, etc. Have a plan, have a strategy, and stand by it. Be consistent. The results will come. Results follow process.
Minimize costs and portfolio taxes. Use low-cost institutional funds, not retail broker-based funds. This will save you money. Minimize trading and transactions. This will save you money. You can control these costs. The less you pay in taxes and investment costs, the more you keep. This is easy to understand in concept, really difficult to practice in the real world.
Have it all written down in an IPS (Investment Policy Statement). Those with written plans do much better in all areas. The IPS requires accountability. It ensures your accounts are marching in unison. They are acting in concert with the plan. If you can’t point to your IPS, then you likely don’t have one and your odds of success are reduced. No doubt.
We must maintain discipline (doing the right things) and patience (avoiding the wrong things). We must have structured investment process in place. It needs to support the plan, not be the plan. Let’s base it on the decades of work of the most credentialed independent researchers. This provides an unbiased approach to help make the most of the long-term power of global markets. Eliminate unnecessary risks, reduce costs, and minimize portfolio taxes over time. Focus on what can be controlled. Allow the principles to work for you. Keep an eye on the prize, those important life goals.
“Investment performance doesn’t determine real-life returns; investor behavior does. Declines are temporary, gains are permanent.” -Nick Murray
