Here are 10 fundamental investing principles that apply to each of us whether we are seasoned portfolio managers or a novice investor.
It never hurts to take time to periodically review these important principles and improve the foundations upon which we make investment decisions.
10 Investing Principles Fundamental to Success
1. Embrace an Investing Strategy
It’s important to know what kind of investor you are and adhere to the principles of your investing strategies. What kind of investor are you; value, contrarian, growth at a reasonable price, growth, or momentum?
If you choose to be a value investor you are at the right place to learn more. I believe investment decisions should be valuation-based. Whichever investing strategies you choose, maintain a consistent approach. In other words, a value investor should not be participated in momentum investing.
2. Invest With a Margin of Safety
If you buy an asset for less than its real value you have a margin of safety. One of my favorite sayings is: Price Matters! The best plan to lower risk is to buy investments at a price that is lower than the real or intrinsic value.
A low price means greater upside appreciation if conditions are favorable. At the same time, a low price provides a margin of safety if circumstances are not ideal. Always plan on less than ideal conditions, something usually goes wrong.
3. Asset Allocation is #1
Your asset allocation, how you divide your portfolio among different asset categories, will be the biggest determinant of your investment returns. I find this is where many investors fail because they put little thought or effort into their asset allocation strategy.
If you place your money into overvalued asset categories you will experience poor long term returns. It’s important to overweight asset categories that are bargain priced and underweight or avoid asset categories that are expensive.
4. Diversification is Vital
Investment diversification in small numbers provides enormous benefits. In other words, five investments is much better than two, ten investments is better than five. However, the marginal benefits of adding additional investments decreases as the numbers get larger until the costs become greater than the benefits.
Both under diversification and over diversification are common mistakes made in portfolio management. Most studies show optimization occurs somewhere between 15 and 30 individual investments.
5. Invest For the Long Term
Short term investing is one of the biggest downfalls of current investing strategies. The truly great investors realize if you buy an investment at a favorable price it may take time for the market to recognize its true value.
Long term investing is one of the most important investing principles because short term trading usually leads to poor long term performance. This is common because many investors let fear and greed cause them to make bad decisions. The long term will take care of itself if you make wise investment decisions.
Related: Mindfulness and Investing for Better Financial Decisions
6. Keep Expenses Low
Most investors don’t realize how much difference high expenses make to their portfolio. Take a look at the example I provide in Mutual Fund Expense Ratio – The Effects on Performance:
Assume:
-$100,000 lump sum investment for 30 years.
-6.5% real rate of return less 0.4% expense ratio for self directed investor.