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Written by Larry Swedroe
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Thursday, 24 September 2009 00:00 |
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Page 1 of 3
Overview: Some of the most complex problems investors face can be solved with simple solutions and prudent investing strategies. The following rules may help investors build and adhere to a well-designed investment plan.
While we search for the answers to the complex problem of how to live a longer life, there are simple solutions that can have a dramatic impact. For example, it would be hard to find better advice on living longer than the following: do not smoke; drink alcohol in moderation; eat a hearty breakfast and follow a balanced diet; get at least a half an hour of aerobic exercise three to four times a week; and buckle up before driving. The idea that complex problems can have simple solutions is not limited to the question of living a longer life.
The following investing guidelines may be instrumental in giving investors the best chance of achieving their financial goals.
Constructing an Investment Plan
- Do not take more risk than ability, willingness or need dictates. Plans fail because investors take excessive risks. The risks unexpectedly show up and the plan is abandoned. When developing a plan, investors should consider their investment horizon, stability of income, ability to tolerate losses and the required rate of return.
- Never invest in any security without fully understanding the nature of all of the risks. If investors cannot explain the risks to their friends, they should not invest. Fortunes have been lost because people did not understand the nature of the risks they were taking.
- A well-designed plan is necessary for successful investing. What else is needed? The discipline to stay the course, rebalance and harvest tax losses as needed.
- A well-designed investment plan has many elements. It should be integrated into a well-designed estate, tax and risk management (insurance of all kinds) plan.
- Do not treat the highly improbable as impossible, nor the highly likely as certain. Investors assume that if their horizon is long enough, there is little or no risk. The result is they take too much risk. Taking too much risk causes investors with long horizons to become short-term investors. Stocks are risky no matter the horizon.
- The consequences of decisions should dominate the probability of outcomes. Investors should ask themselves if they can live with the outcome, regardless of how small of a chance there is of the outcome occurring.
- Avoid working with commission-based advisors. Commissions create the potential for biased advice.
- Only work with advisors who will provide a fiduciary standard of care. That is the only way to ensure that the advice provided is in the investors’ best interest. There is no reason not to insist on a fiduciary standard.
- Separate the services of financial advisors, money managers, custodians and trustees. This minimizes the risk of fraud.
- A strategy is either right or wrong before the outcome. In general, lucky fools do not have any idea that they are lucky. Even well-designed plans can fail because risk (that was deemed acceptable) shows up.
- Hope is not an investment strategy. Investment decisions should be based on the evidence from peer-reviewed academic journals.
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Last Updated on Tuesday, 29 September 2009 10:42 |
