The Three Principles of Investing
In a world of 16,000 hot stocks and cool mutual funds, it is not surprising that many investors lose sight of what investing is all about. To make matters worse, Wall Street will spend over TEN BILLION DOLLARS in advertising revenue this year to try to convince you to focus on hot stocks and cool mutual funds and ignore the 3 principles of investing.
The decision is yours.
Can you afford to make the wrong decision and still reach your financial goals?
The three Coffeehouse principles are based on life-long principles that you already know to be true – and were probably shared with you long ago by someone much wiser than me.
These principles are
- Save for a rainy day. (Develop a long term financial plan)
- Don’t put all your eggs in one basket. (Diversify in different asset classes.)
- There is no such thing as a free lunch (Capture the entire return of each basket, or asset class, through low cost index funds).
1. Save for a rainy day.
Develop a long term financial plan
The first principle is pretty obvious. It’s like having someone tell you to look both ways before you cross the street. Unfortunately, the importance of saving has gotten lost in tin the hype of Wall Street and CNBC.
In the chaos of our everyday lives, it’s easy to bypass the inward responsibility of saving and focus instead on investment things that are out of our control, like daily stock market quotes, quarterly earnings reports and year-end mutual fund summaries, because looking at issues outside of us is a lot easier than dealing with issues inside of us, like our saving and spending habits.
In short, it’s much more fun to do a midyear portfolio review than it is to do a midyear personal review.
Save and invest your next pay raise.
Save and invest your next bonus.
Save more than you spend.
You get the idea.
2. Don’t put all your eggs in one basket.
Diversify in different asset classes
We all know that diversification is important. The problem is, we all want to be diversified as long as we are diversified in the top ten funds in the two hot sectors. Unfortunately, few investors realize that diversification necessarily means that different asset classes will provided dissimilar returns in the short run. At any given time, some sectors are hot and some sectors are not. Instead of wasting your time trying to predict the hot sectors, own all the sectors.
(For a brief review of your asset allocation decision between stocks and fixed income, click here.)
3. There is no such thing as a free lunch.
Capture the Entire Return of each asset class through low cost index funds
Call it what you want, this is where Coffeehouse Investors and Wall Street part ways.
Wall Street, for obvious reasons, would prefer you try to capture more than the entire return of each asset class, in a never ending attempt to “beat the market.” This results in more trades, transactions and profits for them – not you.
For Coffeehouse Investors, it is all a matter of common sense. Capturing the entire return of each asset class is a simple and sophisticated way to build a portfolio, and can be easily accomplished by investing in low cost, tax efficient, index funds (see below).
Exhaustive studies have shown that it is difficult, if not impossible, to “beat the market” over the long haul. And yet that is exactly what Wall Street encourages you to do. The industry survives and thrives by trying to convince you to do what they themselves have proven is virtually impossible to do: consistently outperform a benchmark.
Remember, the decision is yours.
For serious investors, the question is not, “Can I beat the market?”, but rather, “How can I limit if not totally eliminate ‘underperformance’ of the market?”
To look at the futility of trying to beat the market, let’s play a quick game of “Outfox The Box”.