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5 Things I've Learned About Investing

During these next few posts I will focus on a number of topics as they relate to a traditional portfolio investments (stocks, bonds, etc.).  We will cover subjects such as diversification, portfolio construction, and the differences between all the various account types that exist.  In the end, the goal is that you will be better informed on how to properly structure a portfolio for yourself.  This is important, because most everyone owns some type of investment account, whether it be in form of a work retirement plan or something they dabble with on the side.

But before we dig into those details, I wanted to kick things off by passing along 5 insights that I've grown to understand during my journey as an investor and advisor.  Most of these have come courtesy of making a blunder (which when it comes to money, often feels like taking a punch to the gut), so I encourage you to read along in an effort to become a more insightful, less blundersome, investor.

1. The Stock Market Will Humble You

The worst thing that can happen to a young investor is to have success on a high risk bet early on.  This can instill a false sense of confidence that investing is an easy game, or that you simply have the intuition that many don't possess.  Keep in mind that there are hundreds of thousands of individuals out there with advanced, Ivy League degrees and decades of experience who are watching and analyzing the market 24 hours a day.  It is the ultimate, modern-day Gladiator arena.  If you made a market bet and won, it's not because you outsmarted the competition; rather, it's simply because you happened to get lucky.

Chart courtesy of research by Jeremy Siegel

Solution:  Be a disciplined, long-term investor.  While the stock market can be quite the roller coaster ride within the short to mid-term time horizon, the overall trajectory of returns over a long-term time horizon follow a fairly smooth, slow and steady plane higher.

Remember:  The only people who can successfully day trade the market are those that either: 1) have inside information (which acting on is illegal), or 2) can predict the future.

2. Stock Tips are Worthless

This ties into a piece I wrote a while back about avoiding market predictors.  Whether received from a friend, or via a reliable "source", stock tips rarely pan out for those that act on the information.  People love discussing the stock market, which leads to all kinds of predictive conversations based on empty facts.  To this point, a former mentor once told me that one is likely better off taking an opposite bet to the random stock tip(s) they hear.  I have witnessed this advice to be surprisingly accurate over the years!

Solution:  If you have the desire to dabble with miscellaneous investment ideas, establish an account that is separate from those funds earmarked towards your primary financial goals.  Keep the balance small (never more than 5% of your total investable assets), so that any losing play, which will happen, doesn't cause you too much emotional stress.

Remember:  There are two fundamental rules to keep in mind about investment forecasting:

  • Rule 1: For each forecast there is an equal and opposite forecast

  • Rule 2: Both of these forecasts are wrong

3. Overdiversification is a Thing

I will touch on many more aspects of portfolio diversification over the coming days.  But in general, having a blend of assets that perform differently in various market conditions can help your money generate better returns with less volatility.  However, there is a point of capitulation.  When you start adding too many funds to your portfolio, you will likely start to experience overlap and redundancy.  Worse, the increased holdings often create a situation where an investor feels the need to more regularly monitor their portfolio, which will also lead to more stress and a higher desire to trade.  These are two factors that can really diminish success.

Solution:  Keep things simple.  Be honest with yourself and design a portfolio you are confident you will be able to stick with over the long haul.  And if you are not cut out for monitoring your investments, find an investment platform (such as Betterment) or an all-in-one fund (such as Vanguard's target date funds) which take much of the decision making out of your hands.

Remember:  If you feel your portfolio is getting too cute or complicated, there is a high probability that you need to simplify.  Trust your gut.  Leave the cuteness for babies and puppies, not your portfolio.

4. Fees Matter

When it comes to investing, you have to accept the fact that market movements are going to be unpredictable.  This is out of control, which makes it even more important to take advantage of those points of portfolio investing that are in your control.  Investment fees headline a small list of these items that you can regulate.  Vanguard has a great piece highlighting the impact fees have on your long-term returns.  On an initial investment of $100k, even a fee of just 0.65% can mean the difference of nearly $100k in growth over a 30 year time horizon, as seen below.

Chart courtesy of research by Vanguard. 6% rate of return assumed.

Solution:  Focus on building out your portfolio using low cost index mutual funds and ETFs (Exchange-Traded Funds).  A well-structured portfolio can have an aggregate expense ratio of 0.25% or less.  If not sure of the expenses you are paying, search for your funds utilizing an online research service such as Morningstar.  Look to replace your holdings that carry any kind of a "load" (which is basically a sales charge) or an "expense" ratio above 0.40%.

Remember:  Warren Buffet is famous for stating that he has two rules to investing:  "Rule No. 1 = Never lose money.  Rule No. 2 = Never forget Rule No. 1."

I would suggest that a good Rule No. 3 would be to never give your money away unnecessarily.  Knowing your investment fees and keeping them low will help you do just that.

5. Automation Increases Success

I've noticed that most successful portfolio investors establish systems to assist them in their journey.  A systematic savings and investment process will mean less decision making.  Less decision making will almost always lead to better results.  Human beings are emotional and irrational about money; therefore, automation should be thought of as a key ally to minimize the number of touch points required (a.k.a. potential errors made) in your path towards achieving your financial objectives.

Solution:  Put all of your savings goals on a monthly autopilot program.  For your portfolio accounts, make sure to also automate your investment purchases.  Did you have to make manual savings transfers or portfolio transactions last month?  If so, you can automate further.

Remember:  Investment selection and asset allocation cannot make up for a poor savings behavior.  Regular, disciplined savings is by far the most important factor in growing your net worth.

 Are there any insights to successful investing that you have learned over the years?  Feel free to share them in the comments below!