This is not investing advice. Seek a financial professional before making important financial decisions. This article is for informational purposes and should not be interpreted as a recommendation to buy/sell/or trade any security.
Investing can be easy. The challenge is to not give up returns or lose sleep at night. There are no magical formulas, but there are some timeless simple strategies that can help.
No...this is not another “Put all your money in target retirement funds!” or “Stocks for the long run!” article. Some investors seem to think that smart investing can be reduced to directions on an index card. But the more people pile into the same strategy the more inventors bid up the price...so be careful if nearly everyone you know is doing the same thing.
Contrary to popular opinion...we actually think investors should think before putting their hard earned money to work. That doesn’t mean constantly watching the news or spending your evenings reading financial statements. It means keeping your eyes open...understanding how financial assets work ...and understanding your own psychology.
We start with understanding the total universe of investable assets along with their key risks and how they earn you income. We then address the timeless "Dos" and "Don'ts" for smart investing. We then turn to timeless strategies that have helped investors over centuries avoid losing their shirt … which is a more practical and often more profitable goal than trying to get rich quick.
In the next section we discuss Timeless Rules before getting into some Simple Strategies. Think of these rules as ways to avoid doing something stupid. In the strategies we will share some way you may be able to profit from being smart.
What makes for a profitable portfolio changes over time because the world is constantly changing. But there are some timeless rules that have consistently proven out to be helpful in avoiding financial ruin. We organize them into a list of Dos and Don'ts. We then explain each in turn.
Do these things...
Save - When we first got married we lived under the poverty line...but we still saved half of our income. We ate a lot of beans and rice (still do). We bought clothes at the thrift store (still do). We don't buy things we don't use (except foam swords) and most of what we do buy is ultimately a form of investment such as computers for our daughters so they can drive their own education.
Invest - Put your time and money to work for you. Grow your mind by investing your time in education. Grow your heart by investing your energy in relationships. Grow your money by investing in financial assets that provide real value.
Stick to a plan! There are worse things than investing in the stock market just before it crashes 30%...such as selling after the crash, watching the price recover, buying back in, and then watching the price tank again. Make a plan, review periodically (not every time prices fluctuate) and otherwise stick to it!
Benchmark - Know what portfolio is generally recommended for people like you by investment professionals. For many, this is the composition of a target retirement date fund. For us, it is Vanguard's 2060 Retirement Date Fund. A benchmark is a default. Without a great deal of research and conviction...stick with the default. Know what your returns have been relative to your benchmark so you know if you need to rethink your plan.
Reduce Fees - Jack Bogle, founder of Vanguard, did more for the average investor than anyone in history...may he RIP. Use Vanguard for diversified ETFs and Mutual funds...they have the lowest fees in the industry and they don't charge fees for buying/selling. For other ETFs and Mutual Funds...check the expense ratio. Trade infrequently in order to reduce transaction costs. Don’t pay for "active management" unless you have done your research and feel you are getting your money’s worth.
Define Risk - Risk is the potential for permanently losing money, but this definition can mean different things to different people. A highly leveraged hedge fund will define risk differently than most retail investors because short term price fluctuations can wipe them out. Regular folks should not care about short term price fluctuations. They should care about having enough saved up by the time they want to retire.
Account for taxes - Recognize the tax consequences of investments and tax advantaged accounts. Bond income is generally taxed at a higher rate than long term capital gains. Usually that means invest bonds in tax advantaged accounts like IRAs. For all the talk about beating the market...there is surprisingly little excitement about tax loss harvesting...selling short term losers and holding winners. Even if your ability to pick investments is no better than a monkey throwing darts...over long periods you can plausibly beat the market by simply selling short term losers and holding winners...even if you had no luck in picking more winners than losers.
Account for your situation - Your "portfolio" includes both your human and financial capital. Investors often fail to account for their human capital, future income from employment, when investing their financial capital. Diversification matters at the portfolio level. For example, risky employment like a startup should generally be balanced out with less risky financial investments and vice-versa. Also, many have lost everything investing in their employers stock because of "familiarity bias". You already stand to gain if your company succeeds. Don't lose everything if it fails.
Account for extremely bad scenarios - Buy insurance, have an emergency fund, and always keep enough clean food and water in the home in case something really bad happens. If you don't have any idea how bad things can get ... read some history. Then consider how your portfolio as a whole could be impacted by stress scenarios such as a recession (market risk), higher inflation (interest rate risk), government stability (currency risk), capital cycles (industry risk), and any other scenarios that might be specific to your situation (such as getting fired from a company in which you also happen to own a lot of stock.
Focus on the whole portfolio. Don't just buy a stock because you think it's undervalued. Ultimately you should not care about how one asset performs...you should care about how your portfolio performs. Examine how each asset fits into the whole portfolio (including both human and financial capital). For example, someone that already owns a lot of chip companies should be careful about investing in another. You should ultimately care about your entire portfolio...not any particular investment.
Don't do these things...
Don't gamble - This is Warren Buffett's Rule #1, but he calls it "Don't lose money". What he means is don't be frivolous. Be informed by doing your homework. Temperament is the most important quality of a good investor, not intellect.
Don't forget Rule #1 - This is Warren Buffett's Rule #2
Don't put all your eggs in one basket - In other words...Diversify! Have rules for yourself and stick to them. This goes hand in hand with having a plan. For example, having a limit on how much you are willing to put in any one company. Having some larger threshold for how much exposure to any one industry. Have an even larger threshold for investing in any one country. And have limits that prevent over-concentration in any one asset class.
Don't Trust Anyone - Anyone that can beat the market is already rich and doesn't need your money...so don't ever pay anyone "active management fees" unless you know what they are doing (yes, that is a repeat). Investing advice on the news and internet is 99.9% garbage. We also wrote about a few "conspiracy theories" that have some investors fearful of markets for irrational reasons. A handful of leading minds are worth listening to, but only you can be trusted to care about your retirement savings.
Don't do anything unethical - Doing illegal things is obviously stupid. Employers often have rules about what one can and can't invest in. Know these rules and follow them. What many fail to realize is that legal but unethical things are also stupid. Warren Buffett is a great investor in part because he has made it a point to never work with anyone that even comes close to the line. Berkshire Hathaway's many companies run independently because Buffett only buys companies with leaders he can trust to do the right things when no one is looking.
Avoid negative skew - You want to invest in things that have huge upside potential without taking much risk. The statistical term for this is positive skew. Unfortunately, many financial assets can have the opposite...negative skew...or the possibility of large losses but little possibility of large gains. Searching for positive skew doesn't just apply to financial investments. What's the worst thing that can happen when you read a new book, or make a new friend? Not much. What's the best thing that can happen? Life changing opportunities are everywhere. Invest your time and money in things that have positive skew.
Don’t invest based on political views - It’s painful to watch friends and family that think their knowledge of the economy and political leanings can help them make money in markets. But betting on political outcomes is almost as hard as beating markets, and how financial markets react is often unintuitive. Focus on what drives each financial asset class...things like tax policy and regulations that actually affect the earnings power of companies and you may have some luck, but be very cautious of your instincts if your political views are widely shared by most of your friends because that probably means you are more interested in seeking confirmation bias then actually learning.
Don’t do what everyone else is doing, just because - This is the contrarian mindset. If most everyone you know is betting on the S&P 500 because it’s been going up for ten years then this is not a good reason. Everyone has to own all the financial assets in the world at all times. When everyone seems to want the same portfolio, the only way they can get the exposure is if the price goes up. That’s because there is a fixed supply of stock ownership in the top 500 companies in the USA. That which is perceived to be “safe” or “profitable” is often bid up to the point that it is no longer either. So be cautious about investing with herds.
Don’t ignore fundamentals - Every asset class has fundamentals. For stocks its future after tax earnings and the discount rate. For bonds it’s the current interest rate, expected credit losses, and future inflation. For precious metals its real rates and the risks of currency devaluations. For home prices its household earnings and the cost of borrowing. You don’t have to be a rocket scientist to recognize that buying a bond that yields almost nothing is probably a bad idea when government deficits are skyrocketing. Know the basics of what drives each asset class and use some common sense.
Don’t expect past returns to reflect the future - The first thing many investors look at before buying a stock or an ETF is the past returns. They look at charts. They want assets that recently fell a lot but have started to go up. But there are very few patterns in the prices of financial assets (just a few). Some patterns will persist. Some will not. Just because the price fell doesn’t mean its “cheap”. Just because the price rose doesn’t mean it’s “expensive”. Real “value” is when the price is lower than future expected returns and what has value changes all the time.
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