In this quick little guide we’ll go over the basics of a sound, successful investment strategy. I’m going to describe to you the few key points that will help protect you from downturns, and keep your investments safely rising in almost any market.
The first thing we have to do is understand the difference between speculation and investment. They should never be mixed up, and they are very different from each other.
An investor is someone who entrusts some vehicle of the market, be it in the form of stocks, bonds, private investments, or something else to grow his or her money through genuine value growth, business planning, or sound financial management. When an investor hands their money over to a third party he´s doing so after having considered the risks and benefits, and after having taken a good look at the fundamentals and numbers behind a given company or other investment opportunity (e.g: Government Bonds). In essence an investor makes educated decisions and allocations that are based on tangible probabilities.
A speculator speculates: taking risks based on guesses, gut feelings, and trends in the general market that may not have any specific connection to a particular asset. Speculation is basically an attempt to outguess or even predict the timing of market movements.
Bearing these differences in mind, let’s proceed to some basic rules of sound investment management. These mostly apply to stocks, but we’ll finish with a bit said on other kinds of investments.
First Rule: Never get confused
The first rule is that you should never confuse speculation with investment. If you don´t have a very clear series of reasons for trusting the inherent value of the company behind a stock over the long run, then don´t buy into it if you want to call yourself an investor. If you’re investing in the company behind a stock, giving it your money to use for what you think will be carefully planned growth, and intending to keep your investment as part of a planned strategy for a long while, then you may call yourself an investor. If you’re trying to outguess the market, time the movement of stocks, and making hunches based on what’s in the news, then you’re speculating.
Second Rule: Don´t bet the college fund
Never speculate with money you cannot afford to lose. Speculating is fine, it can be fun, and if you’re lucky you might have some great successes, but mostly it depends on pure luck. Are you willing to bet the assets for your future and your children’s futures on pure luck? Probably not, so reserve your speculating only for the money which won´t cause a financial catastrophe if it burns away. Do this by creating an entire separate portfolio for speculative investments and keep the money in the form of liquid cash until you’re ready to make speculative moves.
Keep your speculative actions and the decisions behind them entirely separate from the reasoning that leads your investment actions. The two should not be mixed together at all.
Third Rule: Your real investments
Separate your real investment money, which should always make up the majority of your available assets, and put it into yet another fund. This fund must have nothing to do with your speculation fund, and should be designed in such a way that it can be left unsupervised without worrying about how it will do. Your investments are what you’re depending on for your own, and maybe even your children’s financial security, thus they have to be very reliable. So reliable that you could walk away from them for months at a time and not worry at all.
Fourth Rule: True diversification
Make your investment portfolio diverse. Now, a lot of people view diversity as selecting a few stocks from each of a whole array of companies, or maybe buying into the S&P 500 or DJIA stock indexes. This is a mistaken assumption, and although it protects you from the downs of individual stocks, it doesn´t protect at all against the collapse of the entire market. Sometimes nearly every stock goes downhill, and the very few that don´t are impossible to foresee. By diversification, I refer to something far more genuine and secure; real diversification.
Fifth Rule: Five Steps to safety
Diversify for real, and create far more financial security. A truly diversified and secure investment portfolio is made up of several pillars, each consisting of a totally different kind of asset. Thus, break your available investment capital four or five different ways evenly (e.g.: 10,000 being split into five quantities of 2000 each). Having done this, invest one part into stocks (especially stocks that are volatile, with good earnings and revenue fundamentals and without debt far in excess of assets); one part in precious metals, especially gold and silver; one part in bonds, especially long term bonds which come from an issuer that is as unlikely to default as possible; one part, perhaps, on real estate in markets where prices are not far in excess of reasonable for the size of the property. Finally, keep one part in the form of cash or equivalents: assets such as U.S treasury bills, money market accounts, or the foreign currency of a low debt, financially stable country.
Now that you have the five parts of your genuinely diversified portfolio set out, you can rest easy knowing that no matter what happens in the markets, short of an asteroid impact or global nuclear exchange, you will do well over the long run. This is because in any market; deflationary, inflationary; recessionary, or bullish, at least a couple of your pillars will do well, balancing the whole out over the long run. Now it´s time for the last rule, adjustment.
The Sixth Rule: Adjustments
You have to adjust your portfolio periodically. The best option would be on an annual basis. As the portfolio matures, certain assets will sometimes grow much faster than others, thus the stock component could wind up making up say 50% of the total value. This once again destabilizes your growth and creates too much volatility. Thus, every so often, take whatever has grown to beyond 20 or 25% and sell off the excess, redistributing the windfall amongst the others evenly. Do the opposite if one has dropped particularly after the same time, add enough to increase it back to 25%. This way you would be systemizing the principle of buying low and selling high on an annual basis, while also keeping a percentage of the growing or declining asset pillars for the possibility of their even further growth.
These are just some basic rules, and there are many others which could also be tried and found to work better, at least for the short run. However, with the portfolio rules described above, you’ll at least be providing yourself with the security of a very stable and problem resistant investment program. This is exactly what you need if you’re sincerely keeping your long term future in mind.