The final principle of investment wisdom to be discussed is - hold for the long term.
Yes - You can't hope to jump in and out of the market based on guesses as to direction with any success. You would have to be right about market moves about 70% of the time just to equal the return on a long term holding strategy for the same time period.
But - Be sure that you have made the appropriate time frame decision for your investment goals. If you are saving for a furniture purchase, a home downpayment, or any other short term goal with a definite dollar amount in mind you should NOT be in the stock market! Ever! No matter what hot stock tip your brother-in-law came up with. This money should be in a money market fund, cash, savings, CDs, perhaps a short term high quality bond fund.
Stock market investments should be made with a MINIMUM five year commitment; and given most recent market behavior, perhaps, ten years. So, your 401k, your college savings (for younger children) and any other investments with this longer time horizon can be put out in the market, because these longer time periods smooth out the short term risk.
And, even most long term portfolios also contain some cash or bonds because of the stabilizing effect on returns over the long time period, providing a somewhat smoother ride.
Saturday, September 20, 2008
Investing Wisdom? Yes, But...continued
The second principle of investment wisdom is to buy low (cheap) and sell high (expensive). This is similar to the major principle of weight control, which is to eat less and exercise more. Both of these principles are difficult to apply, given human behavioral tendencies.
Yes - it's obvious. If you sell a holding for more that you paid for it, you make money.
But - you must evaluate your holdings, especially funds, to see if the particular investment that you hold is still a good representative of its asset class for your portfolio. Sometimes, fund managers make serious goofs (they are human just like the rest of us) that damage their performance (and your results). If, after sufficient research, you believe that you could do better with a different international large company fund, there is no harm in selling the "B" fund and buying the "A" fund, even if your "B" fund has hit a low. This is somewhat similar to a football team replacing a player. You have the same team but a new individual in the same position. Morningstar (http://www.morningstar.com/) is a good research tool for ferreting out the best funds. By "best" funds, I mean the funds that are good representatives of their asset class, not the hot performers. I am NOT recommending that you constantly replace funds because they've slipped from five stars to three stars. Read the analyst's comments before you decide that the fund simply doesn't have a place in your portfolio any more.
Yes - it's obvious. If you sell a holding for more that you paid for it, you make money.
But - you must evaluate your holdings, especially funds, to see if the particular investment that you hold is still a good representative of its asset class for your portfolio. Sometimes, fund managers make serious goofs (they are human just like the rest of us) that damage their performance (and your results). If, after sufficient research, you believe that you could do better with a different international large company fund, there is no harm in selling the "B" fund and buying the "A" fund, even if your "B" fund has hit a low. This is somewhat similar to a football team replacing a player. You have the same team but a new individual in the same position. Morningstar (http://www.morningstar.com/) is a good research tool for ferreting out the best funds. By "best" funds, I mean the funds that are good representatives of their asset class, not the hot performers. I am NOT recommending that you constantly replace funds because they've slipped from five stars to three stars. Read the analyst's comments before you decide that the fund simply doesn't have a place in your portfolio any more.
Investing Wisdom? Yes, But...
Sorry to have been away so long. It's been an interesting month, in the Chinese sense.
During periods of market turmoil, we are all reminded by the best advisors and investors in the world of the basic principles of investment sanity. However, these principles should not be applied blindly, or you may make mistakes despite your diligence. In this next series of posts, I'd like to lay out these principles and explain how they should be PROPERLY applied, and when they don't work.
Principle #1 - Buy and Hold
Yes - chasing hot stocks or funds is amusing in the short run but disastrous in the long run. A properly designed portfolio has a DIVERSIFIED set of holdings representing multiple asset classes that have been put together with a plan in mind. Any one holding at any one point in time may not look like it's doing well - which is normal, as different assets perform differently in varying market environments - but the portfolio as a whole will progress over time. Yes, when the market goes completely nuts (as it has recently) everything seems to go down, even bonds, but that's a temporary condition.
But #1 - be sure that you have a diversified portfolio. If you own five large cap growth funds and nothing else, you are not diversified. You will be the victim of the ups and downs of a single asset class. More of the same is not diversified
But #2 - be sure that you rebalance! This is the essence of another principle to be discussed later (buy low, sell high). Especially after a period of market craziness, your portfolio may no longer look like its original design - you may be too high in bonds and too low in small cap equities. At this point, when you rebalance, you sell some of the "winners" (bonds) and buy some of the "losers" (small cap equities). Sell high (bonds), buy low (small cap equities) - sounds right, doesn't it? However, psychologically, this can be difficult which is why you must have a planned portfolio and make a commitment to stick to the plan. Who wants to sell their safe Treasury bills and buy scary stocks this week?
During periods of market turmoil, we are all reminded by the best advisors and investors in the world of the basic principles of investment sanity. However, these principles should not be applied blindly, or you may make mistakes despite your diligence. In this next series of posts, I'd like to lay out these principles and explain how they should be PROPERLY applied, and when they don't work.
Principle #1 - Buy and Hold
Yes - chasing hot stocks or funds is amusing in the short run but disastrous in the long run. A properly designed portfolio has a DIVERSIFIED set of holdings representing multiple asset classes that have been put together with a plan in mind. Any one holding at any one point in time may not look like it's doing well - which is normal, as different assets perform differently in varying market environments - but the portfolio as a whole will progress over time. Yes, when the market goes completely nuts (as it has recently) everything seems to go down, even bonds, but that's a temporary condition.
But #1 - be sure that you have a diversified portfolio. If you own five large cap growth funds and nothing else, you are not diversified. You will be the victim of the ups and downs of a single asset class. More of the same is not diversified
But #2 - be sure that you rebalance! This is the essence of another principle to be discussed later (buy low, sell high). Especially after a period of market craziness, your portfolio may no longer look like its original design - you may be too high in bonds and too low in small cap equities. At this point, when you rebalance, you sell some of the "winners" (bonds) and buy some of the "losers" (small cap equities). Sell high (bonds), buy low (small cap equities) - sounds right, doesn't it? However, psychologically, this can be difficult which is why you must have a planned portfolio and make a commitment to stick to the plan. Who wants to sell their safe Treasury bills and buy scary stocks this week?
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