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Tuesday, June 11, 2013

Simple Investment Rules Not Simple to Follow

Having a well-thought-out investment approach is important.  The last thing you want is for a market to move significantly and to not have a pre-thought-out approach.  This is exactly where investors make critical errors.  In fact, it is central to the book discussion of Millionaire Teacher by Andrew Hallam I will be hosting starting June 20th.

I feel, along with Andrew Hallam and other giants in the field of investing, that using low-cost index funds and sticking with an asset allocation is the best approach for most individuals. But, if you see yourself as a big time trader and want to jump in and out of the market or particular stocks, it's alright with me - go for it. I  and the others believe, however, that you should at least consider the evidence for the index approach.  This evidence is presented in the book and will be looked at in the book discussion.

The index approach has as its foundation 3 simple, basic rules:

  • control your emotions
  • diversify
  • minimize fees
On the surface, it's hard to get more basic.  Surprisingly, at least to those who don't take the time to look at the evidence, utilizing these simple rules has outperformed a high percentage of professional investors over the years!

Still, despite being simple to state, they are not always simple to follow unless they have been well thought out.  For example, some individuals cannot follow the "control your emotions" dictum.  Even in mundane markets, they are following their account hourly and letting the quality of their day be controlled by whether the market is up or down.  In a 10% correction, they will tend to bail; and when the market is on a tear, they over invest.  They are classic "buy high, sell low" investors.

Those investors who cannot control their emotions need professionals to handle their investments.

"Diversify" (aka "don't put all your eggs in one basket") seems easiest to follow.  It isn't.  I sometimes joke that, if Enron had invited me to give an investment advisory presentation on 1/1/2000, it could have been short and sweet.  I could have walked to the lecturn and just said, "diversify your retirement funds out of Enron stock."  The fact is that many Enron employees had their retirement funds invested 100% in Enron.  And why wouldn't they?  Enron had been named the "top innovative company" in the U.S. for 6 years running!  It had been named a top company to work for.  Surely, if you worked at the headquarters, you saw first hand the "geniuses" calling the shots - in all of their smug arrogance.

Those who would have followed the simple diversification rule would have had a completely different retirement than many former Enron employees have experienced.

I know some of you are nodding and saying, "OK, but I wouldn't have fallen prey to Enron."

Well, how about this - as we have found out, many in the U.S. (and probably globally) had their retirement plan wrapped up in their house and more generally, in real estate.  The plan was for house prices to continue ever upward by double digits (sort of a sophisticated version of the baseball card collection retirement plan) and in the end to exploit this by selling and going to an apartment or downsizing, etc.

This is what happens when people buy the biggest house they can afford and their funds are siphoned off into mortgage payments in lieu of a retirement account spread among various sectors and asset types.  The painful aftermath of this "all eggs in one basket" approach will be felt for a long time.

The diversification issue shows up in different guises!

But that's what markets are about.


1 comment:

  1. Great advice Robert! Whether one likes to index or follow individual stocks, diversification is so important. Investors will do well to learn about asset co-relation as well.