by Jeff Reeves | July 19, 2012 10:18 am
Everyone has their list of sure-fire investing rules. The iconic Jim Cramer over at TheStreet.com has 25 rules. Franklin Templeton has 16. And there’s no shortage of sites that parse the general wisdom of investment icons to come up with artificial lists — Merrill Lynch legend Bob Farrell had 10, apparently, according to MarketWatch’s Jonathan Burton.
Well rather than aggregate all of these tips in one place, I figure I’d cut out the noise and just get right to the point. After all, in the vein of the 10 commandments bit from George Carlin there’s a lot of redundancies and hype in these lists that can just be consolidated.
So here’s my list: the ONLY five investing rules you need to follow:
As Berkshire Hathaway (NYSE:BRK.A, BRK.B) chairman Warren Buffett famously said, “Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.” It’s great to make it rich on Wall Street, but if you are fueled by greed first you might as well go to a casino or play the lotto. Retirement planning is as much about protection as finding market opportunities. Capital preservation isn’t the kind of thing people brag about… until they retire with all that money, that is. Don’t accept high risk just for high reward, because losing less money is just as powerful in some markets (like this one) as making more money.
Jack Bogle is one of the patron saints of investing thanks to pioneering the no-load mutual fund and low-cost index investing. You should take a page out of the Bogle handbook because beyond pursuing investments that hold their value in the market, you need to think about investments that don’t bleed you dry in fees. When possible, pick a low cost ETF that uses the same benchmark instead of a higher cost mutual fund. Don’t actively trade stocks unless there’s a compelling reason to, since swing trading can cost you more in transaction fees and capital gains taxes. And most importantly, don’t pay for anything if the performance isn’t there. This goes for investment research tools, subscription newsletters and the like. After all, if you spend $2,500 a year on advisory services and trading fees but fail to outperform the market… why wouldn’t you just move your money into a passive ETF indexed to the S&P 500? It’s not nearly as interesting, but it’s a heck of a lot less expensive.
My favorite thought about the need for diversification actually comes from the SEC: “… have you ever noticed that street vendors often sell seemingly unrelated products – such as umbrellas and sunglasses? Initially, that may seem odd. After all, when would a person buy both items at the same time? Probably never – and that’s the point. Street vendors know that when it’s raining, it’s easier to sell umbrellas but harder to sell sunglasses.”
In other words, while stock picking is fun we should never get too caught up picking the best sunglasses when it is bound to rain eventually. So diversify – by asset classes through the proper mix of stocks vs. bonds, and by sector even when some of those industries may not be in favor right now. If all you do is run after fashionable investments, you wind up chasing your tail – and perhaps missing an opportunity to actually make money on a rainy day.
DALBAR, a financial services market research firm, annually performs a Quantitative Analysis of Investor Behavior study. It’s interesting to see how they dissect the data with a bent towards human emotion, and their report for 2011 includes a very telling line:
“The unprecedented ups and downs of 2011 drove up the aversion to risk and investors succumbed to their fears. They decided to take their losses instead of risking further declines. Unfortunately, as is so often the case, this occurred just before the markets started on a steady trek to recovery.” In short, paper losses became real losses and investors trying to protect their cash by selling actually only hurt themselves more. Or even shorter and more bluntly, as put by Barry Ritholtz, “You are your own worst enemy.” (Bonus: Check out Barry’s blog The Big Picture for a great series of posts about investor mistakes.) Understand this and guard against it. There are indeed cases when you need to jump out of a crashing stock and open your parachute just to survive, but a little turbulence is no reason to abandon ship.
Many people have rules like “do your homework” or “read everything that’s out there before trading.” I won’t take that bait. Because unfortunately there is no clear right or wrong answers and oftentimes investors see what they want to see. So simply doing research is not enough. After all, story telling is what we do as humans – particularly those of us with a penchant for blogging. It’s easy to talk yourself into a bad stock, to talk yourself out of a good stock and to lie to yourself about your strengths as an investor. While some of these other tips may be relatively easy to achieve with discipline and strategy, the idea of brutal honesty about your investing goals and track record is challenging for all of us. But in the long run the only thing that really matters is if we make it to the finish line at retirement with the amount of cash we deserve based on a lifetime of hard work. The rest is just self justification.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at email@example.com or follow him on Twitter via @JeffReevesIP.
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