“The secret to building a successful common-stock portfolio isn’t to “beat the stock market” over the next two years, it is to capture its entire return over the next two decades.” – Bill Schulteis
I’m always interested in finding simple ways to explain the complex topics that are involved in the world of finance. My basic premise that less is more requires simplicity over complexity.
The Coffeehouse Investor by Bill Schulteis is a book that does a wonderful job of this by explaining a few very important and simple investing principles.
Here are his 3 principles of investing:
1. Don’t put all your eggs in one basket.
The key to building a successful portfolio is to diversify your assets in such a way that you maximize your chances of reaching your financial goals with a minimum amount of risk.
2. There is no such thing as a free lunch.
Because the markets are efficient, any attempt to beat the market is likely to prove disastrous to your long-term financial health. Thus, it is essential that you capture the entire return of each asset class, a goal easily accomplished through low-cost index funds, and leave it at that.
3. Save for a rainy day.
Developing a long-term financial plan, with a keen eye on your saving and spending levels, is essential for you to reach your long-term goals.
Very simple, yet very effective. Focus on a broadly diversified asset allocation of index funds and make saving a priority. If that’s all you know about investing you are 75% of the way there.
This is not the only way to attain your investment goals, but it’s a great way to increase your probability of success.
DEAL OR NO DEAL?
Schulteis also has one of the best explanations for the choosing index funds over active funds that I have seen. He lays it out like a game. Let’s says you were given the following line-up of dollar amounts and you can pick any one that you would like:
So which one do you pick? Obviously, the $10,000 amount, since it’s the highest value.
Now, let’s keep the same amounts, but move them around a little and add some suspense:
Think of this one like the game show Deal or No Deal. You can either choose the $8,000 as a sure thing or you can take your chances and choose another box that could have any of the other numbers listed above. It could be more (either $9,000 or $10,000) but it could also be much less ($1,000 – $7,000).
If given the same set of probabilities you would be a fool to turn down a surefire $8,000 for the small chance of making a little more when your risk of making less is much higher.
That’s index investing in a nutshell. You’ll never have the best return, but you increase your odds of success over other investors by taking the low-cost, high probability bet. You could choose the $10,000 active fund but your chances are slim.
Keeping expenses and transactions to a minimum is one of the keys to successful long-term performance. In the book, Schulteis gives a stat that says under 10% of the millionaires in the US consider themselves to be “active” traders and 42% of them make less than one transaction per year in their investment portfolio.
Investors need to be able to gauge their risk tolerance to have a coherent asset allocation plan in place, but many use measurements of risk that are way too complex. Schulteis explains that investment risk should be defined as the possibility that the money you need to buy something or use to sustain your lifestyle in the future won’t be there when you need it.
WHY INVEST IN STOCKS?
Investing requires a leap of faith that things will be better in the future than they are today. Schulteis gives this reason for investing a decent portion of your investments in stocks over time:
The collective creativity of human beings based on the premise that this unending flow of ideas, combined with our innate desire to improve the quality of life of ourselves and others, will not stop anytime soon.
This was a solid book filled with plenty of easy to understand information for investors to use to their advantage. Taking complex ideas and turning them into simple lessons is not easy, but this book does a great job with that. Another common sense book that can help your bottom line.
The Coffeehouse Investor