3 Simple Investment Principles To Keep You Out Of Wonderland
As a newcomer to financial planning, entering the world of investing without some basic principles to follow can feel a lot like Alice tumbling down the rabbit hole. All of a sudden, you find yourself in a bizarre alternate reality where normal, everyday language is replaced with “securities,” “beta,” “alpha,” “tranches,” “futures,” and “REITS.” You can’t always tell whom to trust with your questions, and even then the answers may be as mad as the Hatter. Where do you begin? How do you begin?
While no single article will make you an expert on finance or investing, there are a few basic investment principles that can help put you well ahead of most investors – even some who consider themselves professionals. For the sake of simplicity, I’ve distilled these principles into three categories, each starting with the letter D. Think of it as viewing the world of investing in 3D.
“Would you tell me, please, which way I ought to go from here?”
“That depends a good deal on where you want to get to.”
“I don’t much care where –”
“Then it doesn’t matter which way you go.”
The first and most important investment principle to remember is direction. If you don’t have direction, you will always be lost. To think about it another way, if you have no goal, you cannot measure progress. Direction is the first step in building your financial plan. Ask yourself two questions: where am I now, and where do I want to end up? Figure out your goals and then plan how you will get there.
Establish Investment Goals First>
Before you decide how to invest, and where to invest your money, you need to understand where you want to end up. Goals should be both qualified and quantified, meaning they should be realistic and well defined, both in terms of time and cost. Don’t be discouraged easily – some goals that seem lofty at first may not, upon closer investigation, be all that far out of reach. For example, “I want a million dollars” might not be realistic by tomorrow, but in 10 years, it may well be. Decide how much you need and when you need it, then invest to accomplish that goal. Your goals should control your decisions, not the other way around.
“Take some more tea,” the March Hare said to Alice, very earnestly.
“I’ve had nothing yet,” Alice replied in an offended tone, “so I can’t take more.”
“You mean you can’t take less,” said the Hatter: “it’s very easy to take more than nothing.”
While wandering directionless can be a damaging experience, it is nothing compared to the madness you will experience without diversification. A non-diversified investment portfolio is akin to Alice’s conversations with the Mad Hatter of Wonderland; nonsensical, frustrating, and despairing. One minute you will be elated, mistakenly thinking that you’re a stock-picking genius, and the next you will suffer crushing defeat.
To put it simply: Diversify, diversify, and diversify some more. Invest in funds that hold thousands of stocks, not hundreds. Invest in international and emerging markets, invest in real estate (publicly traded REITS are the most efficient; avoid non-traded, illiquid securities), invest in bonds, invest in small companies, invest in large companies, invest in value companies, and invest in growth companies. Don’t fall victim to the changing whims of stock pickers, “experts” on TV or print, economic forecasts, or any other meaningless predictions about the future.
Let your direction control how much you allocate to each of these markets, but never concentrate your position in one stock, sector, industry or country.
“I can’t go back to yesterday because I was a different person then.”
“How puzzling all these changes are! I’m never sure what I’m going to be, from one minute to another.”
Last but not least, a strong sense of discipline is essential in the world of investment, for the undisciplined investor is always but one step away from disaster. All the good work you may have done in the past can quickly disappear if you choose to forgo your discipline and chase returns or panic in a downturn. Once the groundwork is laid and you have a goal with diversified investments, staying disciplined is paramount. There will be periods of amazing growth and rapid decline, and human nature will be screaming at you either to be greedy or pessimistic. Ignore both urges, and instead focus on only the variables you CAN control. Heads roll with the undisciplined passions of the Queen of Hearts, and your portfolio could stand to lose just as much.
Neither you nor anyone else can predict or control where the market goes from day-to-day, so don’t let its fluctuations derail your plans. Focus on the things that matter: how much you save, how much you spend, taxes, diversification, and your direction. Discipline is only realistic if you frame your success and failures by things you personally control.
Putting It All In Perspective
While Alice’s Wonderland and the wonderland of investing can both seem quite loony, these rational principles will hopefully make your own journey less maddening. It is also important to note that almost every investor will be better off working with a trusted partner who can help them navigate the individual nuances and complexities of their financial world. In the absence of that, I will leave you with a summation: ignore the Cheshire Cats with their large grins and dubious advice, ignore the Mad Hatters with their hot stock tips and market forecasts, ignore the Red Queen of emotion and bias, and above all have direction, diversify your investments, and stay disciplined.