Investing Rules #1 — Don’t invest in what you don’t understand.
When stock prices go down, where does the money go? If you don’t possess a complete understanding of the answer to that question, you do not know enough about stocks to invest in them.
It’s not enough to kinda sorta understand an asset class in which you are invested. You must truly understand how that investment choice works if you are to have the confidence needed to stick with it through hard times.
Investing Rules #2 — Maxims and rules of thumb have limited value.
The purpose of maxims and rules of thumb is to present a simplified take on reality. There’s value in that. The human mind can only take in so much information at once. Maxims and rules of thumb help us to recognize important realities by focusing on the truth being conveyed while leaving out the detail.
Maxims and rules of thumb rarely express complete truths. Please be wary. Listen to maxims and rules of thumb. Do no come to accept them as gospel truths. Do not employ them in circumstances in which their core insight does not apply.
Investing Rules #3 — The 80/20 rule applies.
Most people are reluctant to try to learn about investing because it sounds complicated. There are indeed aspects of the investing project that are complicated. You don’t need to know about that stuff. If you come to possess a sure grasp of the basics, you will know more than 80 percent of investors. It does not take much work to learn the basics. Putting in 20 percent of the time that it would take you to know everything there is to know about investing will put you ahead of 80 percent of investors.
Investing Rules #4 — Investing takes place in the real world.
All of us know a good deal about how to buy stuff as the result of our experiences in a place we fondly refer to as “The Real World.” Many of us disregard many of the lessons we have learned when we enter InvestoWorld because “experts” tell us that the rules are different in InvestoWorld. No. InvestoWorld is part of The Real World. Investing strategies that do not pass The Common-Sense Test should be disregarded, no matter how many Big-Shot Experts endorse them.
Investing Rules #5 — Some investing realities are counter-intuitive.
InvestoWorld is part of The Real World. It doesn’t follow that every investing reality is immediately obvious to us. All investing realities are understandable. There are cases in which it takes a little bit of thought to come to an understanding of an investing reality.
Do investors who take on more risk obtain higher returns? The Common-Sense Rule at first might suggest to us that this should be so.
It’s not so, at least not always. If investors were always entirely rational, they would insist on being compensated for taking on risk. In the real world, investors are not always entirely rational. Investors sometimes choose asset classes that carry high levels of risk but that offer low long-term expected returns.
There is no real conflict with The Common-Sense Rule here. Don’t people sometimes make bad choices in dating or in their eating habits or in the clothes they wear? We’re humans, not robots. Emotions are a factor. That’s so with investing too. Adopting a common-sense take does not mean denying that emotions affect human decision-making.
Investing Rules #6 — There is no One True Way.
Is there one type of house that is better than all the others? Is there one type of spouse that is better than all the others? Is there one type of mouse that is better than all the others?
These are stupid questions.
There is no one investing approach that is better than all the others.
There might be one that today is best for you. Your circumstances might change. You might need to mix in some strategies used by those following other approaches. Start thinking that the approach you use today is the one that is always best for everyone and you lose access to the insights being developed by the millions of people following other approaches. Dumb.
Investing Rules #7 — The bottom line is not obtaining a good return.
The bottom line is living a good life. The purpose of investing is to supply you with the income stream you need to help you live a good life.
Getting mixed up on the core goal of investing can lead to all sorts of confusion and trouble.
Returns are quantifiable. The “good life” concept is not. We are all drawn at times to seek assurances that we have made good decisions by reducing things down to their quantifiable elements. If your friend obtained a better return than you, it may be because he took on a level of risk not appropriate for you. The fact that your return is smaller does not show that your choice was bad.
Assessing investment strategies by comparing the returns they have provided over short time-periods is like assessing potential marriage partners by comparing their “vital statistics.” Super-dumb.
Investing Rules #8 — Long-term investing is something entirely different.
“Buy-and-hold” has become a popular catch-phrase. Most of today’s investors think of themselves as long-term buy-and-hold investors.
The reality is that we are still in the early days of coming to understand what it means to be a true long-term buy-and-hold investor. We call ourselves long-term investors. But we assess strategies by looking to short-term results (results for time-periods of less than 10 years).
Long-term investing works. There is a lot more to it than most people realize.
Investing Rules #9 — It’s not just about retirement.
We don’t save only to retire. We don’t invest only to retire.
Stocks today (this article was posted in January 2007) offer a poor value proposition over a 10-year time-period. Stocks today offer a good value proposition over a 30-year time-period. Does it follow that, if you are 35 and do not expect to retire until you turn 65, you should be invested mostly in stocks? I say “no.”
Your accumulated savings will do a lot of good things for you between now and the day you retire. It might help you buy a bigger house. It might help you start your own business. It might protect you from worry about a recession or a corporate restructuring.
You should consider the value propositions of the various asset classes at all of the time-periods that matter to your hopes of achieving your most important life goals.
Investing Rules #10 — The experts cannot do it all for you.
When you have problems with the electricity in your house, you call in someone who knows how to fix that sort of problem. You call in an expert.
When your daughter asks you for advice on which college to attend, you consult experts, but you add to the mix your own particular take, which is rooted in an understanding of your daughter that only you possess.
Investing is in part a math project. The experts can help with that aspect of the project. There are lots of good books available.
Investing is primarily a Life Planning project. That part you have to do yourself. There is some material available today on how to do this, but not nearly enough. I am in the process of writing a book that will explore this aspect of the investing project in depth. For now, it is important that you not be swept up by the focus on calculation that is present in much of the investing literature into thinking that investing is primarily a math project. The math is important but secondary.
Those are the investing rules. For those who live in a house. For those who are in love with a spouse. And for those who share living space with a mouse.