Top 10 rules of investing

February 12, 2014

Managing investments is often complicated there are a few simple rules that everyone should follow.  Are you and your advisor following them?

Recently I met someone that proudly manages his own money.  In an attempt to impress others in the group with how much he knew he asked ‘Which way do you think the market is heading?’  ‘I don’t have a crystal ball so I don’t know.’ I said.  He let us know I passed his test.  ‘If you would have said one way or another I would say, don’t hire this guy.’  He then went on to describe how he had positioned his portfolio for where he thought the market was headed.  Remember, these rules can only help if you if they are followed not just recited.

1. Test yourself – Before investing and when major changes in your life occur, take a risk tolerance questionnaire.  This will help quantify how much risk you would be comfortable with, in your portfolio.
2. Lay out a plan – Do not just rely on rules of thumb to make your investing decisions.  Your situation and goals are not typical.  If they are then you must have the average 2.3 children.
3. Invest without emotion – Allowing your emotions to guide your investing decisions will cause you to break rules 4 + 5.
4. Buy low and sell high – You invest to make money, this is the only way to do it.
5. Know your limits – If your asset allocation starts to drift away from what you are comfortable with according to your risk tolerance questionnaire it is time to rebalance.
6. Diversify – Different asset classes are like legs of a stool but only when they are not positively correlated.  If the values of your different asset classes behave similarly then you are not truly diversified.
7. Avoid chasing returns – Once the price of an investment goes up it’s time to sell not buy.  FINRA has warned about chasing returns in Structured Products, the manager of Yale’s Endowment has warned against it in mutual funds.  The best performers this period are not likely to repeat the performance.
8. Take advantage of market movement – As the market goes through cycles, follow the asset allocation laid out by your risk tolerance questionnaire.  Rebalance as often as necessary to keep your allocation within the level of risk you can tolerate.  This will cause you to make money during an up or down cycle by capturing gains and buying low.
9. Keep tabs on your money – Most people do this through hiring managers (investment managers, fund managers…) so watch the managers to make sure they are doing the job you hired them to do.  If you bought a condo to rent you would check in on the place more than every 10 years.  Your investments need attention too.
10. Prioritize – Paying for college is a very nice thing to do for your children but if it means you’ll be asking for money to cover your prescriptions in retirement you should rethink your priorities.

Even when you know the rules you may not follow them.  When the cars around you on the highway are traveling 80mph you may drive a little faster than usual.  However, if your car gets picked out at the speed trap you are the one that has to pay the fine.  Follow these rules and you’ll be much more likely to enjoy personal financial success.