Since being involved in the finance industry for almost 20 years now, I have learned quite a bit through the highs and lows of the market. First and foremost, everyone in the finance industry is selling something. It is either a product, service, advice, ideas, or anything that would separate your money from you. That’s the goal, to make money by offering to make you money!
Unfortunately sometimes it is hard to distinguish the good from the bad. The best thing in my opinion is to follow set principles that you can use to screen anything that comes your way. Investing in my opinion is critical if you want financial independence. There is a reason why compound interest is called the “8th Wonder of the World.“ It could be investing in real estate, a business, in the stock or bond market, or even in yourself. But it has to be done correctly.
Here are the principles that I believe every investor should adopt as a system or process, for making sure you are investing in the right things. These investment principles are simple, which in itself should be a part of your investment philosophy. Don’t invest in anything that you don’t understand. Just because it is complicated, it doesn’t mean it is better. In fact (just like the mortgage backed derivatives showed us in 2008) it usually means higher fees for the person selling it, and lower returns for you!
Here are the principles that have worked well in any market environment:
- Know thyself. Know your goals, your risk tolerance (how much risk you are willing to take for a higher return) and where you want and need to be financially in the future. This is different for everyone. Your needs are unique. This is why one investment product can’t fit like a cookie cutter. If anyone is trying to sell an investment or insurance product that they say is perfect for everyone…run. Investing is very personal and needs to fit your style, personality, and caters to you. Going through the financial planning process will help you navigate through this. For our clients, through an in-depth data gathering process, we make it our primary objective to make sure we are able to understand our clients intimately. Only in this manner can we give advice that is in their best interest. If your adviser doesn’t take the time to do this and is only concerned with selling you a product, it may not be the best fit.
- Know your portfolio. Once you know where you want to go, you need to know how to get there. Your investment portfolio needs to be set according to your goals and objectives. This means choosing the right allocation of investments. In other words, build a diversified portfolio that matches the risk and return you are willing to accept. Studies show that over 90% of a portfolio’s gain comes from your asset allocation. It is determined by how you spread your investments out among different types of investment vehicles, such as stocks, bonds, alternative investments, and cash. Market timing and investment selection make up less than 10%! This won’t guarantee that you will always make money, but helps lowers your risk and maximizes your return.
- Know your costs. With every investment, there are costs. You don’t want to overpay or get ripped off, but you also get what you pay for. If you invest in high commission and high expense investments, your portfolio will have to increase by that much over your target rate to break even! I had a client who moved over to us and during our portfolio analysis we found out he was paying over 5% per year in fees! That means in order to get a consistent 8% return, he had to get 13% every year. Given that he was close to retirement, no investment could offer that return with the safety that we needed. Even an extra 1% in costs can add up to tens of thousands of dollars over the lifetime of the portfolio. Having said that though, if you have no desire, knowledge, or time to manage your finances, it is worth paying someone to do it. If you do, ask how that person gets paid. Is it a commission or a fee? The difference is important since how an adviser gets paid can be the main motivation for the advice and investment products you get.
- Know when to Rebalance. If your portfolio allocation is split between stocks, bonds, cash, and alternative investments, over time the allocation gets skewed as some asset classes grow or shrink more than the others. In this case, rebalancing helps you sell expensive assets and buy cheaper assets relative to one another. Since your asset allocation makes up over 90% of your gains, it is important to keep your target mix. It is a simple but sophisticated strategy that can keep risk in check, sell stocks that are doing well to lock in any gains, and buy or keep them during the downturns. It takes discipline and also keeps you disciplined!
- Know when to Reevaluate. Your investments shouldn’t be static, they need to be dynamic. In other words, don’t invest and forget, but invest and re-check. Monitor your portfolio and financial plan on a regular basis. When there are major life changes, your portfolio may have to change with it. There were many stories from the 2008 crisis where those nearing retirement didn’t rebalance or check their investments on a regular basis and lost a good chunk of their retirement savings. If they had reallocated as they should have, the losses would have been less! Checking often keeps you accountable as well. It is also wise to keep spouses in the loop. Reevaluate with them, it will help everyone be on the same sheet of music!
Although investing can seem intimidating, these simple investment principles can help you navigate through the investment world. With investing such an important part of financial independence, it makes sense to work with someone that also follows these principles or taking the time to do it yourself. If done properly, you will be thanking yourself years later! (I am sure your kids will be too!)
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