“Life is really simple, but we insist on making it complicated.”
We all try to overthink things in life. We try to make the easy more complex because we think that if it was easy, everyone would be doing it. When it comes to your investing do not overthink it. Simple is almost always better in the long run. If you try to make your process too complex you will never stick to it. Or it may work once but never again. So apply a little common sense and use these easy to follow rules to keep it simple:
1. Have a plan that you can stick to through all markets
Creating a plan ahead of time will allow you to take your inherent emotions out of the equation. An investment plan is much more important that what funds or markets you invest in. Having a process will keep you from trying to predict what the market will do next week, next month or next year.
2. Don’t speculate, invest
I’ll let Benjamin Graham handle this one: “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”
And John Bogle, founder of Vanguard says “by absolute, mathematical definition, speculation is a loser’s game and investment is a winner’s game.”
3. Dollar cost average
This isn’t as fun as putting a big slug of cash in the market at once and seeing your investments rise. But the downside is you could also lose a lot using this strategy. So invest on a periodic basis, either monthly or bi-weekly depending on when you get your paycheck. When the markets are down you’ll be buying more shares of the funds you invest in. When the markets are higher you will be buying lower amounts of shares. This will keep you honest from making emotional short term decisions.
4. Don’t try to time the market
Do you have a friend or family member that loves to tell you about the times that they go to the casino and win big? Like it was because of their superior skill over the game. Think back to how many times they’ve told you about how much they lost. Probably never. Because we only like to brag about winning. The same thing applies when investors time the market. They love to tell you how they sold out at the top. But did they also buy back in when the market fell? More likely they held out even longer and missed the rebound. Timing the market requires being right twice – when you get out and when you get back in. You have to get the timing right and the direction right. That’s a lot harder than it sounds.
5. Use index funds or ETFs
By investing in these products you take the guessing game out of play. You get the market return less a minimal fee. There is no trying to anticipate what funds or industry will outperform because you will be getting the market average no matter what. Index products have lower fees, fewer transaction costs because they trade less (making them more tax efficient), and are more diversified. In 2011, 84% of active mutual funds underperformed the S&P 500.
Vanguard’s Bogle on index funds says, “When the dumb money realizes how dumb it is and buys an index fund, it becomes smarter than the smartest money,” and typically outperforms about three-quarters of the street’s brightest and highest paid stars.
6. Stay away from individual stocks unless you have time to do the homework
You should only invest in individual stocks if you have the time to actually put in the research and follow them on a consistent basis. Even then it is a tough job. If you do decide to invest in individual stocks make sure it’s only with 5-10% of your overall investment balance so you don’t spread yourself too thin on a few stocks.
7. Have goals in mind with your investments
You should set ranges of outcomes to benchmark yourself along your investment journey. If you plan on retiring in 30 years, come up with a reasonable goal for the amount of capital you’ll need to retire comfortably based on a variety of market returns and saving assumptions. That way you can check your progress along the way to see if you are on the right path to hitting those goals. If not, save more. If you are, stick to the plan.
8. Diversification matters
Diversifying by asset class and within markets is an easy way to spread your bets and lower the risk of major losses. A stock can go to zero. An entire index of stocks cannot. There are times when it won’t matter and everything goes down at the same time (like 2008), but in most situations, diversification across markets gives you the advantage of having investments that zig when other zag.
Within your investment plan, you should have an asset allocation plan by dividing your investment funds and asset classes into certain target weights. At least once a year (more if you want to stay closer to your risk tolerance) rebalance to those weights so you don’t stray from your plan. Most fund companies offer automatic rebalancing of your funds so you just set it up and forget about it.
10. Don’t pay attention to the short-term market movements
It’s good to know what’s going on with your investments but markets rise and fall for a number of reasons and they are not always what the headlines say. If you want to know what’s going on find a reliable market observer who has a successful track record. Don’t watch CNBC. They are a sound bite network and are usually preaching the wrong investments at the wrong time. Even the well-balanced prognosticators they have on the network don’t get enough time to make their point. It’s like listening to sports radio with people shouting over each over to make their case. Ignore the short-term noise and focus on attaining long-term goals. Is a short term drop in the value of your retirement portfolio really going to matter to you by the time you retire in 10, 20 or 30 years?
11. Match your risk profile and time horizon for all investments
Should I buy Apple stock now? I get this question all the time. I don’t know until you tell me how long you plan on holding it for. Also, will this be a long-term holding in a retirement account or a short-term trade in a taxable account? Do you have a plan for when to sell? A price or valuation target? Are you going to sell if the stock falls? Or buy more? If you can’t answer these questions you haven’t thought about how this or any investment fit your personal investment profile. Your decisions should be based on more than will this stock go up this year.
12. Save at least enough for the company match in your 401(k)
If you don’t know how much to save for retirement when you’re just starting out, at least put enough in to get your company match. That’s a nice 100% return on your money no matter how the markets behave. From there, put aside just enough so that it’s a little painful so save. You’ll grow into it.
13. Review your investments on a periodic basis
Don’t look at your investment accounts every day because that can be counterproductive. If you’re hanging on every tick in the stock market you’ll drive yourself crazy and make short term decisions. But it helps to look at your balances and performance on a quarterly or semi-annual basis to make sure things are going according to plan. This helps with your periodic review of your goals. Make sure to aggregate all of your accounts together in one place for a broad overview of all of your assets.
14. Don’t ever buy a product that makes a promise for an exact return number per year
We’ve all had people tell us about the can’t-miss investment opportunity that their advisor got them into. They tell you they can get 10% a year and never lose money. Or they were promised 8% a year and they’ll never have to touch the principle balance. My first question when I hear about these “investments” is what are the fees you are paying? And is it even possible to take out from your principal balance? Be very suspect when someone makes you a precise investment promise. More than likely they’ll end up rich on your fees and you won’t know what your limitations are on the investment until you really need the money. If they can really guarantee you that return why would they share this strategy with you? Sometimes knowing what not to do is half the battle.
Technology offers so much simplicity with our investment accounts. You can set it up so your 401(k) plan automatically takes money out of your paycheck every time you get paid. You can also automate your savings to your IRA or taxable investment account on a periodic basis. And as I said before, rebalancing to your target asset allocation is as simple as setting up an automated trigger on your fund company’s website to make the changes for you to get back in line with your investment plan. Automate these saving and investment decisions and you take the emotion and hassle out of your hands and worry about more important things in your life.
I’ll go more in-depth on many of these topics in the future but over the long run they should all make your life easier and save you investing headaches that come with complex strategies. Use your common sense and keep it simple.