While there are likely countless things we need to know to be successful investors over the long term, here are seven I believe are most critical now. The global financial markets have never seen such uncertainty and volatility brought on by COVID-19. I hope you find these investment tenets helpful.
1) Know Yourself
In the August of 2018 issue of ALIVE Magazine, my Investor’s Edge column was about rules-based investing. I highlighted my “Top 10 Tenets”. These are investment principals that have guided my investment decision making process for most of my 35-year career. Number 2 of those 10 is “Know Yourself”. I also call this the “Be true to you rule”. Knowing your unique investment parameters and constraints will help you stay true to you. An individual investor must know him/her-self to be a successful investor. You must be able to answer fundamental questions about yourself relative to investing. There are no wrong answers. Just an honest assessment of who you are as an investor. The goal here is to ensure you only own investments that are consistent with the type of investor you are.
2) Know Your Investments
Some investments offer relatively high income and little appreciation potential. Others are growth investments that offer great gain potential and little or no income. Still others offer a moderate amount of both. Some are high risk, while others are stable with relatively low risk. There are tax advantaged investments and investments with no tax benefits. Those, and other attributes, are easy to know. When I say “know your investments” I mean KNOW your investments. What are ALL the costs and expenses? How liquid is it? What is the quantifiable risk? What amount of leverage or debt does it have? How experienced is the management team? How does a particular investment complement your overall investment plan? As you have heard, “You can’t judge a book by its cover.” That wisdom applies to investments. You have to do your homework. Open the prospectus. Read the financial statements.
3) All Investments Are Risky
Bernard Baruch famously said, “There is no such thing as an investment without risk.” It’s true. Think about the safest investment in the world; a U.S. government guaranteed bond. It is guaranteed by the full faith and credit of the U.S. government. BUT it is still not without market risk. If you need to sell it when interest rates are climbing, you will likely get less money back than you invested. That is because of a basic investment fact: bond prices move inversely to interest rates. So, when rates go up, bonds go down. Conversely, bond prices rise as interest rates drop. There many types of investment risk, from liquidity risk and market risk, to currency risk and interest rate risks, for example. There is no such thing as an investment without risk.
4) Good Companies Not Always Good Stocks
I have often discussed the notion of “good company; bad stock” with clients. This concept is counterintuitive. Logic would suggest a good company should also be a good stock. The reason here is in part a function of where a company resides relative to industry groups. I monitor 197 industry groups daily. Think of the travel industry today in the face of the global coronavirus pandemic. Comprised of airlines, cruise lines, hotels, resorts, casinos and the like, the travel industry group consists of hundreds of companies. Many of those, such as Southwest Airlines, Marriot, MGM and Carnival Cruise Corp are widely viewed as good companies. They are really bad stocks, though, now (as of April 17, 2020). I know it’s obvious: while we are ordered to “shelter-in-place” and travel has essentially stopped, these companies are not profitable and therefore are bad stocks. The good news is the best of these “good” companies will be “good” stocks again. There are certainly many other factors that prove this concept true. Most industries move one way or another relative to macro-economic conditions. Telecommunications, utilities and real estate stocks, for example, are interest rate sensitive. They, like bonds, trade inversely to interest rates. Therefore, they tend to go down in price and interest rates go up. Those good companies are then bad stocks.
5) It’s Time in the Market, Not Timing the Market
I mentioned my “Top 10 Tenets” above in need to know #2. Time in the market, not market timing is another. It is critical to know for successful investing. Throughout the ’80’s and ’90’s I taught an investment class. “Market timing” was a popular topic with the students. I talked them out of it. A key to successful investing is time; it is the amount of time in, not the timing, that matters. Time in the stock market does two things: It reduces risk and avoids the cost of being out. The longer your time in the market, the lower your risk. Quite simply, no one can consistently time markets. Fact is no one knows the future, and there is no “crystal ball”.
6) Know How to Diversify
Common wisdom isn’t always the best wisdom. Diversification is common investment wisdom. For some it may not be wise. The opposing investment approach to diversification is “concentration”. Maintaining a ‘less-is-more’ conviction, concentrated stock investors choose to invest a lot of money in a few companies. Holding 5-8 stocks is a concentrated portfolio. The best of the two is answered by which is best for a specific investor. Too much diversification can dilute profit potential. Too much concentration can be dangerous, also. Knowing your investor-self will help you with concentration vs. diversification. Diversification is a time-tested way to reduce risk. Just know the right amount for you.
7) Tax-Deferred Compounding Secret to Wealth Accumulation
Albert Einstein is known to have said, “Compound interest is the eighth wonder of the world.” Why so? And, why should you know? It’s in the numbers and works like magic – – especially if the interest (or return on your investments) is compounding tax-deferred. This phenomenon is truly exponential. You should know this because it is this concept that, through your 401k for example, will allow you to retire rich. Another wise man worded what Einstein said differently. According to Benjamin Franklin, “Money makes money. And the money that money makes, makes money.” That is probably the simplest explanation of compound interest you’ll ever hear.
Stay healthy and invest to be wealthy.
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