Today I am going to share with you 10 principles of successful investing.
1. Build a solid foundation before investing
Pay off all debt and build an emergency fund of 3-6 month’s worth of your expenses before you start investing.
An emergency fund helps protect your investment portfolio by providing you with margin and liquidity (the ability to easily access funds when you need them).
2. Invest for the long-term
In investing, time is your ally.
Historically, the longer the holding period, the less risk of a permanent loss.
Between 1928 and 2015, the S&P 500 index had a gain in 72% of the 1-year periods, 86% of the 5-year periods, 93% of the 10-year periods, 99% of the 15-year periods
and 100% of the 20-year periods.
Since the market has historically experienced a loss every 3.5 years on average, you should not invest funds you will need in the short-term, otherwise you may experience a permanent loss when you go to access those funds.
3. Understand the power of compound interest
Compound interest is when you earn interest on both your original investment (principal) and the previous interest you earned.
It is a mathematical explosion. Be very clear about the opportunity cost of spending money now vs. making regular investments over time, so you can appropriately balance the two.
A wise investor, Charles D. Ellis, said “time is Archimedes’ lever in investing.”
4. Risk and expected return always go together
Two key risks in investing are: volatility (short-term) and inflation (long-term).
Investments such as CD’s have lower short-term volatility but also lower expected returns, and hence are more susceptible to the insidious effects of inflation over time.
Investments such as stocks have higher short-term volatility but also higher expected returns and hence offer a better chance of the growth needed to keep ahead of inflation.
It is critical to create an investment plan for your unique situation that appropriately balances between volatility and expected return.
5. Don’t put all your eggs in one basket
Diversify your portfolio with asset allocation.
It’s important to diversify both within and across asset classes.
An example of diversifying within an asset class would be to purchase stock in multiple companies rather than a single company.
Many ETF’s are good for this kind of diversification.
An example of diversifying across different asset classes would be to have some investments in stocks, some in bonds and some in real estate.
You can further benefit from diversification within each of these asset classes (for example large-cap vs. small-cap stocks, domestic vs. international stocks, short-term vs. intermediate-term bonds, etc.).
A properly diversified portfolio has historically resulted in lower risk vs. return.
6. Fees matter
There can be many different fees associated with investing.
There are ongoing management fees for a mutual fund or ETF.
If your fund has higher portfolio turnover as a result of an active management strategy, you’ll pay for higher trading costs and probably more in taxes as well.
And, if you hire an investment advisor, you’ll pay them a fee too (often as a % of the value of your portfolio).
Even though you do not see the money leaving your bank account, all of these fees are paid with real dollars (your dollars!) being extracted from the value of your investment portfolio.
The compounding of costs can have a corrosive effect on your portfolio over time, eroding away its value.
Numerous studies have shown that it is not past performance but low costs that are the best predictor of future (relative) fund returns.
I recommend a long term buy-hold- rebalance strategy which uses low-cost, no-load index funds, coupled with the services of an investment advisor that charges for their time to help design, and if desired manage, your investment portfolio.
7. Take a simple but strategic approach
Investing doesn’t have to be complicated.
You can create a very well-diversified portfolio that is easy to implement and maintain using a handful of low-cost index funds.
Create an appropriate strategic asset allocation (based on your unique situation), and then regularly rebalance to your strategic targets (I recommend annually).
Using a simple, strategic approach increases the chances of sticking to your plan in volatile times, reduces your costs, gives you your fair share of the market returns, and takes less time and energy (so you can focus more on what’s really important in life).
8. Don’t invest in something you don’t understand.
You should be able to explain what you are investing in to someone else.
If you can’t, don’t do it.
Too many people have been separated from their money by a complicated investment they didn’t understand.
Complicated investments, while they may seem sophisticated, most often favor the issuer and/or manager of the investment, and not the investors.
9. Never invest using borrowed money
While leverage (borrowing to invest) does increase the possibility of a big gain, it also increases the probability of a big loss, which you probably can’t afford.
Use time to your advantage, don’t try to get rich quick, steady plodding is the best way. Remember the tortoise and the hare.
10. You aren’t going to get rich overnight through investing
A proper investment is one that has at least a five-year horizon.
Said another way…
Any investment that can double your money in a month is likely risky.
You could lose all your money just as quickly.
If you don’t adjust your thinking in line with this, chances are you’ll end up losing a lot of money.
Ignore what’s happening right now.
The market moves today are not relevant to your long-term goals. People who want the daily excitement of winning or losing end up gambling and that’s a sure way to lose money.