Successful investors are successful because they adhere to a set of principles. This post outlines ten essential investment strategies you need to build wealth. In short, if you’re wondering how to get rich without getting lucky, this article is for you.
There’s nothing flashy about wealth-building as it relates to the majority of ordinary people. Read The Millionaire Next Store, and you’ll understand what I mean.
What I discuss below are ten investment rules (or commandments) and the importance of each one.
1. Think Long Term
If you only look at the short-term moves of the market, you’re going to drive yourself crazy. Emotional decisions are usually not the right ones.
I’ve used this illustration before, but look at these two stock charts and tell me which stock you’d rather own:
Well, you may have already guessed, but they’re the same stock on different time scales. Both are charts for Starbucks.
The one on the left is from a recent six-month period. The one on the right is from the prior ten years.
If you sold all your Starbucks shares ten years ago based on seeing something like the chart on the left, you would have missed out on 800% in gains. Over 40 years, that would turn $1000 into over $4 million.
The market is like a river – always going downstream.
Your boat will make more progress by just staying in the water and going with the flow rather than if you took your boat out of the water every time the current slows.
One caveat, however, is that the closer you are to needing your investment money, you’re going to have to consider your exit strategy and start shortening your time horizon.
2. Invest What You Can Afford
Fear of missing out is a real thing, even with investing. You see your peers all making a lot of money in the financial markets and you want in.
But just like buying a house when you can barely afford rent, investing money you can’t part with is a recipe for disaster.
The internet is replete with tips that go against the notion that you need to “have money to make money,” but that’s just a way of getting clicks at the expense of your financial security.
Prudent investors need a moat to protect their financial castle.
Apart from my retirement investing, when I opened a brokerage account to do some opportunistic investing, whenever I put money into the account, I asked myself one question:
Would I be in trouble if I lost every penny of this money?
If the answer was “yes,” I just didn’t do it. The key to staying in the market long-term is that you’re not going to need that money any time soon.
Loss aversion is a strong enough motivator by itself to get out of the market before you should. Needing the money for a credit card payment would just seal it.
Prudent investors need a moat to protect their financial castle.Tweet This
It’s not the same mindset for retirement investing. With that, you have other factors to offset any short-term losses, or at least to make early withdrawal very painful.
On the front-end, you sometimes have a company match or tax deduction for giving you a head start. On the back-end, you have more tax benefits and penalties to save you from yourself.
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3. Buy What You Believe In
Buffett is famous for saying, “Never invest in a business you cannot understand.” It’s not that you have to be intimately aware of everything that goes on within a company, but you should be able to quickly identify if they are making the right moves based on what you know.
Warren Buffett will never invest in cryptocurrencies. He buys boring
stockslike train companies and Coca Cola.
Why is this? Does he know something about these companies that we don’t? Possibly. But more likely, it’s because these are things he understands.
If you look at someone’s stock portfolio, you should be able to learn a lot about that person’s interests and knowledge base.
In the same vein, you probably will be able to tell if they are just following someone else’s “hot” stock tips because their choices will have no rhyme or reason.
On the other hand, if you carefully follow social media platform trends and can predict the way the tides are turning, then that should determine how you should invest or divest in a company like Facebook.
If you can’t explain to someone in your own words what a particular company does at a most basic level, you should think twice before investing in it.
4. Do Your Research
Does this mean that you have to have an in-depth knowledge of things like P/E Ratios and know each of the Executive Board members’ backgrounds?
Not particularly, but the more you know about a stock, the better your decisions will be.
The bad thing about depending on someone else’s opinion on a stock is that you’ll never know if they’re just guessing, or worse, lying.
You shouldn’t offload your research responsibilities to someone else because either way, if things go south, you have no one to blame but yourself.
If you do your due diligence and your investment fails, then you just made a mistake. Everyone does occasionally. At least you have a learning experience from it.
If you went with someone else’s “tip” and failed, you’re just a sucker.
People who are contrarian tend to do better in the stock market. But to be contrarian, you have to know something that others don’t.
But you can’t know that without doing your research. Otherwise, you’re just following the herd.
5. Set It and Forget It
It’s just another way of saying “buy and hold” with the added point of “… and don’t even look at it again.”
You’ve established the virtues of staying in your investments for the long-term. So what’s the problem with continually checking it every day? Shouldn’t you be on top of your investment portfolio?
Yes, if we didn’t have thousands of years of evolution working against us.
Did You Know?
Evolutionary psychologists explain this as part of a deeply-ingrained loss aversion. We tend to see unfortunate events in our lives as vastly outsized compared to favorable ones.
If our ancient ancestors found an amazing berry patch but one random day a lion jumped out and killed their cousin, you’d better believe that they’re not likely to go back to that berry patch no matter how sweet the fruit. It was a survival instinct.
In the same way, our investments could have seen decent gains most days, but that one significant loss makes getting out seem very appealing.
But if you didn’t see that loss until months later and also saw that those losses had already recovered, you’d probably just let it ride.
So the best way to avoid being bad-news-reactionary is to automate your investing so you don’t even have to confront the choice.
If you’re investing in your company’s 401(k) you’re probably already doing this. It takes a certain amount of your paycheck and invests it in funds you pre-selected.
6. Consistently Contribute
This is yet another way your 401(k) is showing you the way. Your automatic contributions are allowing you to dollar-cost average.
Instead of investing all your money at one time, you spread out your investments over a period. This reduces your risk of buying at the perfectly wrong time.
Plus this turns a bear market into a good thing in that you’re buying more shares of an investment as it’s getting cheaper.
When the market recovers, you’ll have more shares taking advantage of that growth.
Does this necessarily mean that if you have a lump sum to invest right now, you should wait and invest chunks over the coming months or even years? That depends on your proclivities.
Chances are that by investing the lump-sum immediately it will pay off better in the end, even if you do it right before a big downturn.
But if you think that an event like that will turn you off of investing, you could spread out your buying to allay those fears as long as you commit to doing it.
7. Be Fearful When Others Are Greedy
This is the first part of what is likely the most well-known of many mantras of Warren Buffett. It’s also a part of what it means to be a contrarian.
Being contrarian takes advantage of the inertia of people. There are only a few trend-setters but many trend-followers.
This is because people are not only reactionary but also tend to overreact. This is what creates financial bubbles.
Back in the early 2000s, everyone was convinced that there was no way to lose money in real estate.
So people took out ridiculous loans, bought multiple houses, and flipped them. This drove housing prices through the proverbial roof.
Then the bottom fell out and countless people were left holding the bag.
8. Be Greedy When Others Are Fearful
This is the other part of Buffett’s mantra. If people overreact to good news, they go completely irrational about bad news. This is a part of that loss-aversion tendency I mentioned earlier.
But the level-headed among us see this as a buying opportunity. People and the market are pricing things to sell because no one is buying.
If you were in the market for a house in 2009 after the housing bubble burst, you would have seen some really good deals.
This might seem like you’re taking advantage of people who are in a bad situation, but in reality, you’re helping the market to recover.
If all anyone did was sell after bad news, you’d start seeing massive deflation, which can be worse than moderate inflation.
9. Find And Remove Frivolous Fees
It’s important to avoid unnecessary fees, especially in retirement accounts. This is because they are usually a percentage of your assets, not a flat fee.
This means that the more you make, the more they make from your fees. And while one percent of a thousand dollars is only 10 bucks, that same one percent of $200,000 is $2000 and that’s in annual fees.
Also, if you add the effects of negative compounding interest, by the time you’re ready for retirement it will be a healthy chunk of your 401(k) balance. If you have enough of them and with enough time, those fees add up.
It seems obvious, but people ignore the obvious because they assume that the fees have to pay for something… some sort of expertise or insider knowledge.
Nope, you’re just paying for someone’s boat.
Most retirement plans have lower fee options such as
And just like that, you’re making more money in your investments.
Think of diversification as hedging your bets. You may not see massive gains, but you’ll also avoid complete losses.
The point is to spread out your investment risk. Find investments that don’t correlate with each other (also referred to as a minimum variance portfolio).
Anyone can make money in a good economic environment. A well-diversified portfolio can make money in good times and bad.
There are many ways to diversify your portfolio, and depending on how involved you want to get, it can get pretty complicated.
Note: The simplest way to get quick and relatively safe diversification in a stock portfolio is to invest in an index fund or a total market fund.
Or you can work your inner stockbroker and find your own mix of individual
You can delve into the world of corporate, municipal, or even high-yield bonds. It’s really up to you.
Here’s a detailed look at several investment strategies we’ve already covered if you’d like to learn more:
- Coffeehouse Portfolio
- Ivy Portfolio
- Swensen Portfolio
- Lazy Portfolio
- Larry Portfolio
- Permanent Portfolio
- Dividend Aristocrat Portfolio
Billionaire hedge fund investor Ray Dalio designed the All Weather to thrive in any economic environment.
A word of warning, however. If you plan to be more hands-on in your diversification strategy, make sure you know what you’re investing in. Just buying a bunch of
For example, if you were to buy a variety pack of some of the more popular
That’s why the above-mentioned portfolios can serve as an excellent starting point.
There is no perfect diversification mix. One day’s winning formula could be tomorrow’s loser. But with the right asset allocation, you can mitigate certain disaster and make decent gains.