17 Cliches and Rules of the Road When Investing
May/June 2001 Number 10
- Only invest in what you understand. If you don't understand how something works, don't put your money into it.
- Remember that everything is "risky" and nothing is "safe." It is important to understand that there are different degrees and levels of risk, regardless of the investment. For example, over the last twenty years investors who put all their money in "safe" CD's have seen inflation wipe out much of their gains, while investors in "risky" stocks have not only seen their principal grow, but can now spend much more than the CD owners are earning in interest. Risk isn't just the possibility of losing your principal. A major mistake that can be made is to be too conservative with long-term money.
- There is no free lunch. Risk and return are interelated, and if you pay too little attention to this when things are going great, you will probably pay for it on the way down. One of the ironies when investing is that you can be right about what you believe is going to happen, but something you were not taking into account makes the outcome come out differently than you expected.
- Be patient, time is your friend. Let the magic of compounding have a chance to work. This can be tough in the age of the "day trader." Save and invest now rather than later.
- Dollar cost average, continually investing over time. If you get a lump sum at some point (large bonus or inheritance relative to your net worth), be patient and spread out the timing of your commitments. Keep some money in reserve.
- Diversify, don't put all of your eggs in one basket. Own stocks for growth and bonds for income. The professional term for this is "asset allocation." Don't depend on any one investment. Diversify among large and small companies, U.S. and international, in different sectors. As a general rule, don't put more than 5% to 10% of your investment dollars in any one stock.
- Buy and hold. When you have good companies or funds, only sell if their situation has changed enough to warrant selling. In the book "The Millionaire Next Door" the authors point out that 42% of the millionaires they interviewed in their latest survey had made no trades whatsoever in their stock portfolios in the year prior to the interview. By holding stocks you shelter any gains against taxes.
- When in doubt, do nothing. There will always be another opportunity, another "train to catch."
- Run away from "hot tips" or "sure things." Be leery of investments you have to own "regardless of price." Think independently. and don't chase the latest fad. It is amazing how hard people work for their money, and then without much thought will sometimes throw it into something just because someone tells them about a "great" or "sure thing" investment. If you want to gamble, set aside a small amount of play money, no more than 5% to 10% of your investment assets.
- Don't invest for thrills, there are plenty of other things you can do in this exciting world to fill this need besides throwing away money. Use money as a tool to help you achieve what you want out of life.
- Don't try to time the market. Trading systems never work as well in the future as in the past. The future is unknowable.
- Only use leverage (borrowing or options) if you have experienced market cycles. Cut losses short.
- Don't be afraid to take a loss. If circumstances change or you've made a mistake, get out. A common investment trap is to sell stocks that go up too early, and hang onto losers waiting for them to recover. This is a recipe for owning a portfolio of under-performing stocks.
- Don't worry about relative returns. It will drive you crazy if you are constantly comparing yourself to how a certain market or index is doing. Measure your total return against your objectives. A well-diversified portfolio is going to have both winners and losers in any given year.
- Don't overreach for yield. An extra percentage point or two can cost you dearly if interest rates go up. You don't have any control of where interest rates are, or their direction. There will be times when they are low, but this is why you diversify. Generally when interest rates are low, stocks do well.
- Don't be greedy. This causes poor decision-making and invites scams. A fool and his money are soon parted. If it sounds too good to be true, it probably is.
- Do trust yourself and take responsibility for your decisions, good and bad. Don't invest too much self-esteem in the market!
Return to top of page or Homepage
