If you’re going to invest in the stock market (whether on your own or with a Financial Advisor), it’s essential to know what your investing philosophy is. What is going to guide your decisions on how to invest?
The good news is this doesn’t have to be complicated. You don’t need to get an MBA or degree in finance to understand (or create) an investment philosophy.
What you need to do is make sure that you understand, and agree with, the philosophy that you’re going to use. This will not only make it easier to select the proper investments when you start investing. It will also help you keep your emotions in check and focused on your goals when (not if) we go through another recession like we did in 2008-2009.
Here’s my investing philosophy that I use for my own personal accounts as well as what I use when working with my clients:
BE BROADLY DIVERSIFIED
I’m sure you’ve heard the adage “Don’t put all your eggs in one basket.” It’s wise advice, especially when it comes to investing. Instead of putting all your money into one investment, put them into many. That way, if one investment doesn’t work out so well, you still have plenty of other opportunities to make money in the other investments.
But what does it mean to be broadly diversified?
First, let’s start with the location of your investments. We definitely want to have a good portion of your money invested in American companies. Our economy and political stability over the history of our country have been nothing short of remarkable. But we can’t only invest in the U.S.
We also want to invest in the rest of North America, as well as overseas. That’ll include more developed places like Europe, as well as some more developing countries in Asia and Africa. Now it is important to note that investing in some of these overseas countries does entail some other types of risk (like currency, political and economic risk). However, in order to have a globally diversified portfolio, we need to invest overseas as well as here in the U.S.
The specific mix of how much in what country depends on the specifics of your situation. But the main point to understand is that it’s important to be invested in dozens of countries all over the world.
Lastly, we want to make sure that we own large companies, medium sized companies, and small sized companies.
STOCKS OUTPERFORM ALL OTHER INVESTMENTS
This one might be a surprise to a lot of people. According to a survey done by Bankrate, Americans agree that real estate is the best way to invest. And the next best way to invest? Cash. Yup…Cash. Despite the dismal interest rates you can get in a savings account, people thought cash was the second best investment you could make. Stocks came in third after those two.
Hopefully, some of the people that thought real estate and cash were the two best investments are reading, because we’ve got some misconceptions we need to clear up.
But before we do that, let me say this: I get why some people don’t like the stock market. It’s unfamiliar, intangible, and seems risky. People on the TV screaming “Buy buy buy! Sell sell sell!” Talking in complex financial jargon with numbers racing across the screen. What in the world are they talking about?!?
Whereas with cash, you know exactly what it’s going to do. Even if it may not make much, it’s stable and secure. And real estate is a tangible investment. You can go look at it, feel it, live in it or even rent it out. And people will always need a place to live, right?
So what’s the problem with this thinking? Well, let’s look at some numbers:
Via London Business School and Credit Suisse, From 1900 to 2011, home prices, after adjusting for inflation, rose by 1.3% per year. The average saving account today will earn you 0.06%.
But stocks? Over the last 10 years, the S&P 500 has averaged an 13.6% return. And over a longer period of time, like the last 100 years, it’s right around 10%..
Now that’s quite a dramatic difference between what you can get in stocks vs real estate and cash.
My point here is simple: Over the course of decades of investing, the stock market can be a great way to build wealth, and historically it’s been the best place to invest for the long term.
INVEST FOR LONG TERM
This is one of the most important tenants that I adhere to when it comes to my investment philosophy. When I invest for myself or my clients, I only do it if we have a long-term investment horizon.
What does that mean? If you’re thinking about investing money that you’ll need in less than three years, don’t invest it. It’s simply not worth the risk.
Over the long term, a broadly diversified portfolio has a very good chance of increasing in value. In fact, over any 15 year period in US history, the stock market has gone up 99.8% of the time.* Pretty incredible, right?
Source: Blackrock
But over the short term? There’s a lot less certainty as to whether your investment will increase in value. It might go up in the short term, but it also could go down.
And what happens if your investment account is down significantly at the very moment when you need the money?
So if you need money in the next year or two, don’t risk investing it. Put it in something safe and stable instead. That could be a high yield savings account, a CD, or a bond fund (which isn’t guaranteed either), but I definitely wouldn’t put my money in stocks if I really needed the money in a year or two.
But for the money that you won’t need for 3+ (and preferably more) years? That’s money that you can feel comfortable investing.
REBALANCE ANNUALLY
Imagine this: After you determine the right asset allocation for your goals, you put 70% of your money in stocks and 30% in bonds. But over the course of the first year, your stocks do so well that they now comprise 80% of your portfolio, and bonds only make up 20%. In other words, you’ve got a more aggressive investment allocation than you did to start with.
So what do you do?
You rebalance your accounts at the end of every year to get back to your original asset allocation. Meaning, you sell that extra 10% of stocks that you now own, and use the proceeds to buy more bonds, so that your portfolio is back to 70% stocks and 30% bonds. Doing this annually ensures that your investment allocation stays in line with your risk tolerance and your goals.
And on top of that? Rebalancing your accounts can actually increase your returns.
So with rebalancing you can make sure your investments stay in line with your risk tolerance, while at the same time offering the opportunity for higher returns. Sounds like a win-win to me.
DOING NOTHING IS OFTEN THE RIGHT THING TO DO!
“While the interests of the business are served by the aphorism ‘Don’t just stand there. Do something!’ the interests of investors are served by an approach that is its diametrical opposite: ‘Don’t do something. Just stand there!'” Jack Bogle, founder of Vanguard
I imagine that some people won’t like this point. News channels like CNBC have trained us to think that we need to continually keep our eyes on the market, and make changes according to whatever is going on in the economy, the global political scene, inflation, interest rates, etc. Basically whatever external force comes up, there needs to be some reaction to it; something that you should be changing.
I can’t tell you how much I disagree with that.
First, this assumes incorrectly that you need to change your low cost, well diversified portfolio in response to macro events. I don’t think that’s the case. I think your portfolio can excel even if you do nothing in light of big events.
Second, it also assumes that your financial advisor is going to be able to predict what will happen in the global economy, and what the best way to respond to it is.
For instance, right now there is the war with Russia and Ukraine. And if your advisor has some new investment philosophy in light of this war, they have to be able to tell you how long this will last, which sectors of the economy will be hurt the most (other than Russian stock market), they have to determine if other countries will be drawn into this, they have to predict how long this will go on, they have to understand how other actors on the world stage react, etc.
It’s an impossible list for your financial planner, no matter how smart they are, to be able to predict. Our politicians and national security advisors aren’t able to accurately predict all of this, so I think it’s quite a stretch to ask your financial planner what’s going to happen and what changes are necessary to respond to it.
This brings us back to the quote from Jack Bogle earlier. While CNBC and other businesses may think that we need to continually make changes to justify their business proposition, it’s actually in our best interest as individual investors to do nothing.
That is especially true when there is uncertainty in the markets and your portfolio is dropping 10% or more. If you can simply stay invested for the long haul, and wait for your portfolio to recover, you will be rewarded in the long run.
And what should you do when your portfolio is performing well? Well I do want you to monitor your investments and make sure they are still the best ones to have in your accounts, and make sure they are still aligned with your goals.
But as long as both of those things are true, then I don’t see a reason for you to make a chance. In other words, we shouldn’t be making changes just to make a change, as long as your goals are the same and your investments are still low cost and well diversified. We should follow Jack Bogle’s advice: Don’t do something, just stand there.
And there there you have it, five pillars of my investing philosophy. To recap: Be broadly diversified, own stocks, invest for the long term, rebalance annually, and do nothing. If you do that you’ll be well on your way to a great investment philosophy and portfolio.
If you feel like you can do this on your own, awesome! But if you think you need help choosing and implementing the right investments, feel free to schedule a call with me at StartMyRetirement.US where we’ll put together a one page retirement plan as well as review your investments.