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 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 changing of currencies, 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.
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:
From 1900 to 2011, home prices rose by 1.3% per year. The average saving account today will earn you 0.06%. But stocks? Over the last 10 years, they’ve averaged an 8.6% return. And over a longer period of time, they’ve done even better than that (I’m talking almost 10%).
Woah. That’s quite a dramatic difference.
My point here is simple: Over the course of decades of investing, the stock market can be a great way to build wealth.
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 20 year period in US history, the stock market has gone up 100% of the time.*
Pretty incredible, right?
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.
But for the money that you won’t need for 3+ (and preferably more) years? That’s money that you can feel comfortable investing.
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.
Well there you have it, four pillars of my investing philosophy. To recap: Be broadly diversified, own stocks, invest for the long term, and rebalance annually. If you do that you’ll be well on your way to a great investment 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, I’d be happy to see if we’re a good fit to work together. You can email me at firstname.lastname@example.org, call me at 424-258-4460, or contact me here.
*Past performance is not indicative of future results.