It has been three years since the S&P 500 has declined
10% or more from a recent high. Including dividends, the index has more than
doubled in the past five years. The Dow Jones Industrial Average has 34 record
highs this year alone. Even the Nasdaq is less than 6% away from its dot-com
bubble peak. But high returns breed complacency and create a false impression
of how easy investing can be. That makes it a great time to review some
fundamental—if overlooked—investing truths. Here are 16 important rules for
investors to live by.
1. All past market
crashes are viewed as opportunities, but all future market crashes are viewed
as risks.
If you can recognize the silliness in this, you are on your
way to becoming a better long-term investor.
2. Most bubbles begin
with a rational idea that gets taken to an irrational extreme.
Dot-com companies did change the world, land is limited and
precious metals can hedge against inflation. But none of these stories
justified paying outlandish prices for stocks, houses or gold. Bubbles are so
easy to fall for precisely because, at least in part, they are based on solid
logic.
3. “I don’t know” are
three of the most underused words in investing.
I don’t know what the market will do next month. I don’t
know when interest rates will rise. I don’t know how low oil prices will go.
Nobody does. Listening to people who say they do will cost you a lot of money.
Alas, you can’t charge a consulting fee for humility.
4. Short-term
thinking is at the root of most investing problems.
If you can focus on the next five years while the average
investor is focused on the next five months, you have a powerful edge. Markets
reward patience more than any other skill.
5. Investing is
overwhelmingly a game of psychology.
Success has less to do with your math skills—or your
relationships with in-the-know investors—and more to do with your ability to
resist the emotional urge to buy high and sell low.
6. Things change
quickly—and more drastically than many think.
Fourteen years ago, Enron was on Fortune magazine’s list of
the world’s most-admired companies, Apple was a struggling niche company,
Greece’s economy was booming, and the Congressional Budget Office predicted the
federal government would be effectively debt-free by 2009. There is a tendency
to extrapolate the recent past, but 10 years from now the business world will
look absolutely nothing like it does today.
7. Three of the most
important variables to consider are the valuations of stocks when you buy them,
the length of time you can stay invested, and the fees you pay to brokers and
money managers.
These three items alone will have a major impact on how you
perform as an investor.
8. There are no
points awarded for difficulty.
Nobody cares how much effort you put into researching a
stock, how detailed your spreadsheet is or how complicated your options
strategy is. For many people, a diversified buy-and-hold strategy is the most
reasonable way to invest. Some find it boring, but the purpose of investing
isn’t to reduce boredom; it is to increase wealth.
9. A couple of times
per decade, investors forget that recessions happen a couple of times per
decade.
When recessions come, stocks tend to plunge. This is an
unfortunate, but perfectly normal, part of the process—like a Florida
hurricane. You should get used to it. If you are unable to stomach declines,
consider another investment.
10. Don’t check your
brokerage account once a day and your blood pressure only once a year.
Constant updates make investing more emotional than it needs
to be. Check your brokerage account as infrequently as necessary to prevent you
from becoming emotional about market moves.
11. You should pay
the most attention to the investor who talks about his or her mistakes.
Avoid those investors who don’t—their mistakes are likely to
be worse.
12. Change your mind
when the facts change.
Admit when you are wrong. Learn from your mistakes. Ignore
those who refuse to do the same. This will save you untold investing misery.
13. Read past
stock-market predictions, and you will take current predictions less seriously.
Markets are complicated, and human emotions are unpredictable.
Unless you have illegal insider information, predicting what stocks will do in
the short run is unimaginably difficult.
14. There is no such
thing as a normal economy, or a normal stock market.
Investors have a tendency to want to “wait for things to get
back to normal,” but markets and economies are almost constantly in some state
of absurdity, booming or busting at rates that seem (and are) unsustainable.
15. It can be
difficult to tell the difference between luck and skill in investing.
There are millions of investors around the world. Randomness
guarantees that some will be wildly successful by pure chance. But you will
rarely find an investor who attributes his success to luck. When you combine a
market system that generates randomness with a belief that your actions reflect
your intelligence, you get some misleading results.
16. You are only
diversified if some of your investments are performing worse than others.
Losing money on even a portion of your portfolio is hard for
some people to swallow, so they gravitate toward what is performing well at the
moment, often at their own expense.
Click here to access the full
article on The Wall Street Journal.