Every year at this time, the financial media is filled with lists of how to be a better investor.
This got me to thinking: If these lists are so effective, why do we need a fresh set of them every year? Two answers come immediately to mind. First, investors are fickle and easily dissuaded by their emotions, compelling sales pitches and of course the ups and downs of the markets. Second, many of the items on these lists are vague and fail to tell people what they should actually do.
Ignoring that first problem, at least for now, I’m going to propose seven steps you can take that will actually make a difference.
First, let’s look at a few common “rules” that aren’t really useful.
Starting with Warren Buffett, who is widely regarded as the best of the best investors of our era, we find this well-known prescription: “Rule No. 1: Don’t lose money. Rule No. 2: Don’t forget Rule No. 1.”
Sounds good, don’t you think? But as a New Year’s resolution, what does it mean?
Unless your luck is incredibly good, any stock or fund you buy is very likely to decrease in value at some point. If you buy something for $50 a share and five minutes later its price is $49.75, have you violated this rule?
Well no. If Buffett’s advice really meant that, you could never buy anything.
So he must be saying you should never sell an investment at a loss. In other words, hang on forever to anything that is worth less than what you paid for it. Does that sound like a recipe for success? Buffett himself has been known to sell investments at a loss.
Therefore, I have to give this “rule” for successful investing a grade of “D.” Yes, it’s thought-provoking, but it’s not helpful.
I looked at a list of “10 Key Rules of Investing” from John Bogle. Many of them are good, but they fall short of being actionable instructions that tell you what to do.
For example: “Don’t fight the last war. What worked in the past is no predictor of what will work in the future.” OK, but how is this useful? You can’t know what will work in the future, so you’re left to pilot a ship without a rudder.
Fortunately, Bogle’s list includes this: “Stay the course. The secret to successful investing isn’t forecasting or stock picking. It is about making a plan, sticking to it, eliminating unnecessary risks, and keeping your costs low.”
That’s very good, but the key thing point is “making a plan.” What should be in that plan? Will any old plan do the job?
Let’s turn to Bob Farrell, who was Merrill Lynch chief market analyst and senior investment adviser for 45 years. His widely circulated rules for investors contain good insights — but they don’t tell investors what they should do. Three examples:
• Excesses in one direction will lead to an opposite excess in the other direction.
• When all the experts and forecasts agree — something else is going to happen.
• The public buys the most at the top and the least at the bottom.
Still, if you are like most investors, probably 90%, what you really want to know is exactly what to do. Instructions, in other words.
You can always get instructions and recommendations from any broker. But what you really want are recommendations that will accomplish your goals, not Wall Street’s goals.
If your goals include higher long-term returns, less risk, and more peace of mind, you’re in the right place.
1. Save some of your money regularly instead of spending everything. Start your serious savings earlier instead of later. If you can’t sock away a lot, don’t let that stop you. If you can save (and invest) even $25 a week, that’s still $1,300 in a year, $13,000 in 10 years. Do that for 30 years and earn a compound return of 10%, and you’ll have about $214,000. (And once you start seeing the results, I’m willing to bet you’ll find ways to add more than just $25 a week.)
2. Invest in stocks by the hundreds or thousands through low-cost index funds or ETFs in a variety of asset classes. Make sure to include value stocks and small-cap stocks. Massive diversification will reduce your risks. Indexing will almost certainly improve your return as opposed to active management. Including value stocks and small-cap stocks is highly likely to improve your long-term return.
3. Pay attention to taxes. Invest in a 401(k) or similar retirement account if one is available to you — with luck, you could even get matching funds from your employer. Maximize your use of IRA accounts, and choose a Roth IRA for its long-term tax advantages.
4. Ignore what you feel, and put your investments on automatic, using dollar-cost averaging. Don’t let greed or fear determine when you invest. Recall Bob Farrell: “The public buys the most at the top and the least at the bottom.”
5. If you’re saving in an employee plan like a 401(k), make a target date retirement plan the backbone of your allocations. In one simple step, that will accomplish most of the things you should be doing. To increase your long-term return from this fund, allocate part of every contribution you make to an auxiliary fund such as a value fund, a small-cap blend fund, or a small-cap value fund.
6. Loop back to something John Bogle and many others have recommended: Stay the course. Don’t panic and don’t try to time the market.
7. Once you have done those six things, focus on living your life instead of obsessing about your investments. Stop watching the financial news, listening to hot tips from your friends, and reading the pundits who claim (without any evidence, as they say) to know what the future holds.
If you successfully and consistently do these things, I promise you’ll be among the most successful (and probably among the least stressed) investors out there.
Happy New Year!
Investors can learn some important lessons from the year that just ended, as I discuss in my latest podcast.
Richard Buck contributed to this article.
Paul Merriman and Richard Buck are the authors of “We’re Talking Millions! 12 Simple Ways To Supercharge Your Retirement.”