Having spent 9 years of my life trading in stock markets, forex and cryptocurrency, I have come to realize that there are a handful of rules every investor has to follow in order to be successful.
1. Investing is simple, investing rationally is hard
The basic rationale behind successful investing is easily understood: “Invest for the long term, be diversified, watch your costs and let compounding work its magic.” But following through is the hard part.
Few people can “sit there and do nothing.” Most people will come up with ridiculous reasons to justify their impulses, e.g., “I feel lucky today, so I’m gonna buy XXX and hope its price goes up”, etc. Doing this will lead to costly errors and loss of capital that erode returns.
Don’t do things out of “feeling like it”.
2. Behavior is everything
The inability to manage emotions and behavior is the financial undoing of many. To paraphrase William Bernstein, “the extent you succeed in finance is based on your ability to suppress your limbic system. If you can’t do that, you’re going to die poor.”
Even the greatest stock pickers will underperform if unable to control their emotional impulses. Allowing emotional hot buttons to get pressed is how people go wrong in investing. There are no shortcuts, secrets or get rich quick schemes that work, not even those 3-day workshops that promise to reveal the secrets of the ultra-rich for a “nominal” fee.
3. Moderation in all things
Think of the majority of the assets in your portfolio – hopefully a diversified, global mix of passive index funds – as the basic meat and potatoes of investing from which you can add seasonings, herbs and vegetables. Want to do some early stage investing in tech start-ups? Maybe some real estate speculation? Perhaps a bit of private equity investments in non-public businesses? Maybe even a fun trading account?
I don’t have problems with any of that as long as it meets 2 conditions. First, you should understand that the odds of success are against you. Many billions of dollars are aggressively competing in the same space for returns. The professionals are always searching for an edge, and even with one, there are no guarantees of success.
Second, it should be a smallish chunk of your liquid net worth, perhaps about 5% to 10%. That is enough to provide you a little fun and intellectual stimulation. Some might even discover a knack for such investing. But the amounts should be small enough that if the investment doesn’t work out it won’t affect your financial plan.
4. Risk and reward are inseparable
Risk is best defined as the probability of your returns differing from your expected outcomes. The problem is that many investors want better-than-market returns while assuming minimal risk. But returns are a function of the risks assumed.
Risk-free U.S. Treasuries yield almost nothing. To do better, own equities. But that adds volatility to your portfolio. If you seek higher returns, you can add low beta stocks that have the potential to do better – or worse – than the market as a whole.
5. Spend less than you earn
Budgeting is simple: Income goes on this side of your household balance sheet, expenditures on that side and make sure the latter is lower than the former.
I have zero tolerance for the spending scolds who tell you never buy a boat, don’t get a new car, and avoid buying lattes. This lazy, ignorant and poor advice given by charlatans and frauds who do not understand math or finance. If they did, they would add the magic phrase: “… if you cannot afford it.” But if you can, then spend your money however you like but preferably thoughtfully. People often skip purchases they can afford out of misplaced guilt.
6. Leverage kills
Using borrowed money for nearly anything is the negative manifestation of the 3 prior rules. Yes, get a mortgage to buy a house you can afford. But never use borrowed money to buy speculative assets that are subject to further capital calls.
This is NOT to say never use leverage on any investment. Forex trade is a good exception, because there is little return (or loss) without leverage. In this case, you need a good entry and exit plan.
Be cautious on where you put your borrowed money.
7. Understand your role
The markets are populated by all kinds of people. There are traders, investors, hedgers and speculators, and everyone has different risk tolerances, time horizons and financial goals. Do not blindly follow any investing guru’s advice, unless you know their goals are the same as yours.
8. Be aware of your limitations
What gets so many young investors into trouble “is NOT what we don’t know, it’s what we know for sure that just ain’t so.” Understanding the limitations of your cognitive errors and belief systems is just the start. It’s also important to know what inadequacies you have financially, emotionally and behaviorally. Operating outside of your own capabilities is a good way to run into trouble.
9. Own it
You, and no one else, is responsible for your financial well-being. Not the Federal Reserve, the government or whichever huckster is yelling the loudest at the moment. You alone accept responsibility for your investments and spending. The sooner you take ownership of your financial circumstances, the better off you will be.
10. Invest in yourself
This is the most important investment you can make. Educate yourself, develop an expertise and add to your professional skill stack. And invest in your future by making sure you fully fund your retirement accounts every year. Make those long-term investment needs before spending on short term wants.