Principles of Successful Investing
There are almost infinite ways to invest successfully. If success ends with a portfolio large enough to meet your investment goals, whether that be early retirement, putting kids through college, or leaving a legacy, there are countless ways to get there.
You can build a sizeable portfolio over time using any combination of stocks, funds, asset classes, currencies, regions, investment managers, time horizons, contribution levels and investment philosophies.
While the combinations of variables to succeed in investing are almost limitless, there are only a few ways to fail. Since there are so many ways to win and only a few ways to fail, we're going to focus on not losing as this is much more important than trying to win.
If we manage to avoid losing, our chances of winning increase exponentially. So how do we avoid losing? Let's see how you can fail in investing.
Pay high costs.
High costs are like torture for your investment portfolio. The effect is imperceptible in the short term, but in the long term it is devastating. After all, the amount you pay in costs is the best predictor of your future return. For example, by switching from a portfolio with 2% annual costs to a portfolio with 0.5% annual costs, the result is an extra 92% in your portfolio after 40 years, assuming a return of 5% per year. You could almost double the size of your portfolio by doing nothing but cutting costs!
Take concentrated positions.
There's no faster way to lose part of your portfolio than by putting part of it into a single position. The lure of concentration is hard to resist when it has the potential to get rich quick - but investing isn't about getting rich quick. It's about avoiding losses and getting rich slowly. Remember, "You can't have a baby in a month by getting nine women pregnant." Don't act like George Maddox, whose retirement pot was worth $1.3 million when he retired, only to drop to less than $4,000 within months. He had everything invested in shares of one company - his employer - Enron ... !
A concentrated position is an example of failure. But there are even more links in the chain of our investment portfolio. We all know we need to diversify across asset classes, sectors, regions, currencies. But we also need to be safe in all areas related to our portfolio. No amount of asset class diversification will save you if you hand over your portfolio to an unscrupulous product seller who gets paid on commissions.
There are only three ways a smart person can go broke. Women (or men?), liquor and... leverage. Looking back at a chart of historical returns for US/Global stocks, it can be tempting to try and accelerate returns on what has been a reliably fantastic long-term investment. Do not do it! If stocks can fall by 50%, their losses need not be magnified through leverage. No one can lose more than 50% of their money!
Just like paying too much in costs, taxes are also one of the culprits for your wallet. Protect your portfolio against taxes by taking advantage of schemes such as employer pensions. Be sure to manage your capital gains and income taxes for those investments that are held outside of your taxes.
Ignore free money.
Accept your company's retirement plan. Even if the funds you can invest in through your occupational retirement plan are less than ideal, your employer's retirement contributions are always worth more than the best fund choices.
Nothing destroys faster than performance hunting. Whether that's selling everything during a market crash, investing everything in the best performing stocks or abandoning your chosen investment strategy, chasing performance is a surefire way to fail.
Check your portfolio frequently.
This is a surefire route to performance hunting. The more often you check your portfolio, the more likely you are to find a position that has done poorly recently - and therefore more likely to sell your losers. On the other hand, the more often you check that your portfolio is doing well, the more likely you are to get bored with what seems like slow progress and chase faster gains. Don't try to make a baby in a month.
Search for the perfect portfolio.
Average performance over an above-average period lead to extreme performance. Compound interest is not about getting the highest performance. It is about achieving a reasonably good return for as long a period as possible.
Taking too much risk.
Investing too much in stocks runs the risk of capitulating if the market falls. The worst time to discover your true risk tolerance is during a crash. Unfortunately, this happens for most investors. Before investing, make sure you are investing in line with your risk profile.
Taking too little risk.
If you invest too little in stocks, you run the risk of falling short of your investment goals. You will suffer smaller losses if the market falls, but in the long run you will be leaving money on the table by not investing enough in stocks. Those extra returns come at the expense of additional years that you have to remain professionally active, or a lower standard of living when you retire. Before investing, make sure you are investing in line with your risk profile.
Investing and gambling can feel the same. Both are risky and both can make you money. However, the main differences are as follows:
- The expected return on investing is positive (and increases over time), compared to the negative expected return on gambling (which decreases over time).
- Investing is a long-term activity, gambling is a short-term activity.
- It is possible to increase the chance of success with investing, but not with gambling.
- The worst-case scenario is more favorable with wise investing than with gambling.
- Gambling is a zero-sum game, where one person's gain is the other's loss. Investing is a positive sum game where all participants can win.
Not giving it enough time.
Composing is slow. And then it's incredibly fast.
Don't do it.
The longer you wait to invest, the more you need to save to get where you want to be. The market gives free money in the form of compound interest - don't leave it on the table!
If you manage to avoid all these pitfalls, chances are you will win the investment game. If you decide to outsource your investments to us, it means that you are not looking for the perfect portfolio, but that you are taking an appropriate risk so that you move forward to reduce your chance of failure.