The smartest people on Wall Street understand four wonderfully powerful truths about investing. We could all benefit enormously by adhering to these four great truths:
1. The dominating reality is that the most important decision is your long-term mix of assets: how much in stocks, real estate, bonds, or cash.
2. Diversify within each asset class—and between asset classes. Bad things do happen—usually as surprises.
3. Resist the temptation to “tinker” with your plan too often. The discipline to stick with a well-crafted asset allocation plan is often even more important than picking the “right” plan. Market sentiments change quickly and every dog will eventually have its day. Selling an asset class at a recent low and increasing your investment in another asset class that has hit new highs is a surefire way to underperform over the long term. Allow disciplined rebalancing to do the work for you. Don’t abandon a prudent long term strategy based on short term disappointment, or based on the bravado of friends who had a better year. They likely are taking too much risk, are insufficiently diversified and will quiet down after their next big loss. They are also likely underperforming versus you over longer periods of time.
4. Be patient and persistent. Good things come in spurts—usually when least expected—and fidgety investors fare badly. “Plan your play and play your plan,” say the great coaches. “Stay the course” is also wise. So setting the right course is crucial—which takes you back to number 1.
Curiously, most active investors—who all say they are trying to get “better performance”—do themselves and their portfolios real harm by going against one or all of these truths. They pay higher fees, more costs of change, and more taxes; they spend hours of time and lots of emotional energy; and accumulate “loss leaks” that drain away the results they could have had from their investments if they had only taken the time and care to understand their own investment realities, develop a sensible long-term program most likely to achieve their goals, and stay with it.
Less experienced investors tend to abandon well-crafted strategies when they are temporarily down, and become over-exuberant and over-confident when they are up. These emotions are self-defeating in the investment world.
Trying to time the market is the biggest mistake investors make. They sell at the bottom and buy at the top. They get out of stocks when everyone is pessimistic and panic is in the air, and they get in or double down when everyone is optimistic about what is going to happen. They also make a big mistake by constantly trying to pick those stocks that will outperform. Few if any are able to do this consistently.
We are all better off sticking to a disciplined plan based on a broad array of index funds. The goal is to mirror the world’s financial markets without making any big bets for or against any one of them. An even better reason for individuals to index is that they are then free to devote their time and energy to the one role where they have a decisive advantage: knowing themselves and accepting markets as they are—just as we accept weather as it is—designing a long-term portfolio structure or mix of assets that meet two important tests:
1. You can maintain the discipline and live with it through thick and thin.
2. The long-term “expected results” are likely to achieve your long term goals.
Changing managers—firing one after a period of short term underperformance and hiring another who has had some recent success—is also self-defeating. Strategies and tactics that fare well in one short term period typically do poorly in the next. In the industry this known as “dating” and is widely recognized as an expensive waste of time and energy that should be avoided by all serious investors.
So the great advantage of investors who are wisely concentrating on asset mix decisions is that it helps them avoid the “snipe hunt” of a vain search for “performance” and concentrates their attention on the most important decision in investing—long-term asset mix to minimize the odds of unacceptable outcomes caused by avoidable mistakes and maximize the chances of achieving their investment objectives.
If, as the pundits say, “success is getting what you want and happiness is wanting what you get,” investors—by concentrating on asset mix—can be both successful and happy with their investments by living with and investing by the four simple truths—so investments really do work for and serve them.
Of course, as all experienced investors also know, most individual investors take many, many years, make many mistakes, and have many unhappy experiences to learn these “simple but never easy” truths.