The 10 Commandments of Investing

On a plane back from New York, someone sitting next to me noticed I was writing my next blog, and asked me what my “10 Commandments of Investing” would be. A quick conversation led me to rapidly type my thoughts. So, consider this my extremely abbreviated summary of the things you should never forget when investing and planning your future.

Please be advised: these commandments are not listed in any order of priority, so don’t think of “number one” as being the most important. At some level, they are all very important.

Drum roll, please. Here they are, my 10 Commandments of Investing:

1. Stick with the indexes
Leave the individual stock picking to gamblers and speculators. Very few people really understand how to successfully pick individual stocks, and if they do, the news that drives markets today is totally unpredictable, making individual stock picking a highly risky venture. Reams and reams of statistics prove index investing almost always outperforms the financial advisors, money managers, and stockbrokers. Stick with the indexes and you’ll likely wind up far ahead of the game. Care to speculate a bit on some individual stocks? Do it with a small portion of your money, but certainly not the bulk of it.

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2. Watch those fees
Wall Street loves investors that don’t watch their fees. For those investing in funds, check out www.personalfund.com. You might be shocked to find out the total cost your funds are charging you to own them year after year. Especially over the long haul, fees can destroy your returns.

Minimize fees as much as possible by investing in low-fee, highly diversified investments such as one of my personal favorites, Exchange-traded funds such as those offered by www.ishares.com

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3. Create a bond ladder
For income, bond funds are the favorites among many advisors. They’re simple, quick, and unfortunately, sometimes loaded with fees. Consider laddering bonds instead. Why? Mutual funds containing bonds have no maturity dates. If the value of the fund goes down, good luck trying to guess when your principal will “come back.” With a laddered bond portfolio, as long as the bonds don’t default, you have a date when your money will be returned to you.

Creating a bond ladder is not as easy as choosing a few bonds funds; it usually requires the assistance of a skilled advisor. But the next time an advisor recommends bond funds for income, be sure to suggest this as an alternative. Some advisors don’t construct ladders, and if they have little or no experience doing so, I would suggest getting an opinion with someone else before leaping into the funds.

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4. Diversify
You’ve heard it a thousand times, but it’s amazing how few people actually do it. Diversification saves lives and prevents disasters, especially when you don’t put too much money in one place. Also be certain to understand the concept of “rebalancing.”

That’s important stuff, and if you don’t understand it, go back and read a quick intro to the concept at Wikipedia. Rebalancing, together with diversification, will likely one day save your investment life.

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5. Watch your money
No one else will ever keep track of your money like you will. Don’t get lazy and stop paying attention. Read your statements every month and monitor your progress and returns. This is your hard earned money we’re talking about, and don’t ever forget that.

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6. Don’t rush in
You’ve likely heard the saying “only fools rush in.” On every level, rushing into things can cause great harm. Whether it’s rushing in to get high returns, rushing out as a result of emotion, or rushing into a decision as to where to invest, before diving in pause, take a deep breath, sleep on it, and then make your decision. As a “subset” of this commandment, I would also include: Be careful when listening to others. What’s good for one person is terrible for another. The media does a great job of generalizing advice and investments, and I think that’s an awfully dangerous game to play.

Unless someone really understands your personal situation and goals, I firmly believe it’s nearly impossible to make conclusive and general statements as to “what’s good” and “what’s bad” for you. No good doctor could ever diagnose a problem without getting the answers to some basic questions. If they fail to do this, prescribing a pill can literally kill you. The same is true with investing. Only when a few key questions are answered could anyone really give prudent advice on “what’s good” or “what’s bad” for you. So the next time someone tells you to “stay away from this” or “you should invest in that” be careful. Educate yourself, assess the advantages and disadvantages of the advice you’re getting, pause, then make your decision. By doing so, chances are you’ll make the right one.

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7. Don’t take the risk if you don’t need the return
Many people would do perfectly fine getting 7-10% returns on their money, yet their portfolios are invested in things that strive for well beyond that. Especially if you’re a retiree, if you doubled or tripled your money overnight, would you go out and buy a fancy new sports car? A mansion on the hill? Few of us would. And for that reason, always ebb towards the safer side of investing as much as you possibly can.

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8. Get out if something isn’t working
The greatest investors I’ve ever known are the ones who don’t get emotional about their money. I’m not talking about the Warren Buffets of the world. I’m talking about highly successful investors I’ve met who were schoolteachers, electricians, and small business owners. Some of the best investors I’ve met are those who understand that becoming emotional about an investment often leads to disasters. Easier said than done, I know, but this one is very important: Don’t ever fall in love with an investment. It doesn’t love you as much as you love it. So if it isn’t working, cut it off before you really regret it.

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9. Understand tax consequences
I’d place this right alongside number two above. Over time, the tax ramifications of your investments can really help or hurt you. It’s been said that “It’s not what you earn, it’s what you keep.” Amen. You absolutely, positively need to understand the very basics of what happens with your taxes when you move money around, especially if you are investing in mutual funds that often create taxable events beyond your control.

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10. Keep it simple
Only one more commandment? That’s too bad. I can think of so many more favorites — start saving as early as possible, take advantage of compounding, max out your qualified plans, etc. But if I had to pick only one more point to complete this quick “off the top of my head” list, it would have to be to keep it simple.

I once met a very successful investor who did quite well for himself over many years. His entire portfolio consisted of literally three positions: a Standard & Poor’s (S&P) 500 index fund, a low-cost bond fund and a low-cost international stock fund. Other than some cash sitting on the sidelines, that’s it, and not surprisingly, he did better than most investors I’ve met with phone books of investments that re difficult, if not impossible, to keep track of. While I certainly don’t endorse keeping your entire portfolio in three positions (given that I don’t know your personal situation), I can say that keeping it simple is a universal lesson of life itself, and in the world of investing, it allows you to do one very important thing: keep track of what you have and how it’s doing. The more complicated things get, the more room there is for disaster. It really is as simple as that.

It’s a bit tricky narrowing down an entire investing universe to ten points. Perhaps if I was flying from Los Angeles to Florida instead of New York to Florida I’d have more time to think about this. I’m sure as soon as this is posted I’ll regret not including some other things that will come to mind. So, consider the above a random sampling of my mind that in the matter of a few minutes, conjured up the above over two small bags of Delta’s Roasted Peanuts and a Diet Coke (that just spilled all over my Sports Illustrated magazine. What a bummer).

Stay tuned for my next post on the lessons Star Wars teaches us about investing. I’m having fun with that one.