This is an article about my general rules for life and how they apply to financial investing, managing personal cash flow, personal financial responsibility, and social support.
1a. Live in reality.
You are human, just like everyone else, inherently flawed and incapable of thinking clearly. This is not a dig, it is the reality of the human mind and cannot be helped. The one thing you can do is make the best decision it is possible for you to make at any particular time and hope that, on average, it's better than the decisions other people are making with a similar amount of information. To do this you need a system for making decisions, preferably one that focuses on things you've actually observed and facts rather than simply your gut or what your mind finds appealing. Your ego will generally make you feel your decisions are of a certain grade, so instead you must find a way to objectively measure them against others. In stocks, I feel the best way to do this is with "shadow portfolios". Whatever amount you decide to invest in real money, use a portfolio tracker such as google finance to "shadow invest" the same amount of money in good mutual funds and ETFs. I have 3 shadow portfolios: Bonds, Market tracking ETFs, and Everything I'm thinking about investing in. If my real money portfolio is performing better than all three of those portfolios I'm making good decisions, other wise I probably am not. Also don't get caught up in how much you made today, this week, or this year, keep track forever. How you do over time is what's important.
1b. Don't get shot.
Keep no less than 30 days worth of expenses (or 1/2 month's salary, whichever is greater) in a savings account. The interest rate you get on this money is irrelevant, that's not what it's for. The job of this money is to sit there for when you need it. Typically when you're closing your positions the money can be tied up in the paper work with your broker for two to three weeks and unable to be placed into your outstretched hand until that time. And if you need money chances are it is not possible for you to wait, and you can't buy groceries on the courtesy credit your broker extends to buy more stocks. In all honesty however, I primarily use a credit card for this purpose and only keep 1/2 a months salary in my checking account and invest the rest. But I have great credit, high credit limits, and get charged 5.5% APY (most people's credit cards are greater than 12% APY). In this case, I have 30 days to free up the cash to pay for those unexpected needs and since stocks are liquid I probably only need 3 days to 2 weeks to get that cash into my outstretched hand. Still, keeping a fair amount of money in a high yield savings account is a good idea.
2. Be dedicated in funding your retirement
Even if you'll never need of money (like you'll be retiring in a socialist country with a pension plan for all it's citizens), if your company provides matching funds in any amount for a 401k or 403b you are acting terribly foolishly if you don't max that benefit. If you make $100,000 a year and your company matches 7.5% of your salary you're preventing yourself from earning an additional $7,500 a year. That's free money from your employer that you're pissing away because you don't want to put 7,500 of your own money into your own savings account. That's a 100% return, guaranteed, every year by itself! Right now the government limits the amount you can personally put away to $16,500(2010) each year and you should strive to put in every penny to your retirement account. Once you've maxed your retirement contributions, you should channel as much money as you can afford to into the stock market but always something. I like to personally invest 10-20% of my income in addition to the 14% (to a max of 16,500) I put away into my 403b. That's right, I personally save at least 28% of every paycheck simply to invest. My average return is about 15%, but yours will likely differ either better or worse. So that means that if I made 100k last year I contributed $9,000 to my 403b which after one year will be worth $18,975 (total 211% gain) and I saved 10,000 for my personal investments and they're worth $11,500. In total I've avoided spending $19,000 and after one year that ends up being $30,475. That's like having an invisible man work full time for you at McDonald's who's only purpose in life is to earn you money, and he never wants anything in return.
3. Fund your kids retirement
If you have children, you should start their retirement within the first week of their birth. The United States government allows you to pay any individual up to $500 a year without filing employment paperwork with the IRS. So you should pay your child a salary for being cute & giggling (so it's "earned income") up to $500 a year and place it into their ROTH IRA (The IRA you pay your taxes on before investing it). Making only yearly $500 contributions from age 0 to 18 you will have contributed $9,000 and on their 18th birthday that retirement account will be worth ~$20,000 (a 222% increase). That money can be rolled over (I believe without penalty) into a 529 plan to be used for education if you weren't able to sufficiently fund that (but you should be doing that too if you can). If they leave that money alone, and never fund it again for the rest of their lives they'll have $671,352.82 available to them upon retirement at age 65, all tax free.
4. Keep an open ear.
If you're reading this you probably have a physical body, and if you have a physical body it is limited to biological reality and corporeal space. You simply do not have enough time or ability to do enough research on your own to be successful, you will need to get ideas from others. You may not need their advice, but you do need their ideas. Chances are if someone has suggested it to you other people are thinking about it too, so it'll behoove you to pay attention and act fast.
5. Due diligence and searching for yourself.
Any idea you get, whether you are it's originator or not, needs to be researched and tested for validity. Try to get as much information from as many different sources as you can, and as many view points. Often media, particularly American media, is a perpetual hype engine that will cheer on any container placed in front of it with any liquid in any amount. And before you buy even a single bottle of Yak Piss you should know what's in the bottle, what Yak Piss is useful for, and what sort of return you can get for it. Are you getting a fair price? Getting a shares of a Great Company (like Coca-Cola) at a decent price is many times more valuable than getting shares of a decent company at a great price.
6. Don't be afraid to walk away, cash in hand.
One of the best preforming "hedge funds" of all time had a mean ("average") of 50% of it's total assets in cash at all times, but more often than not (mode) 70% of it's total assets were in cash. Don't be afraid of cash and it's meager returns, if you invest properly your gains will blow away Bonds, CDs, Treasuries, and all other financial instruments (other than a winning lottery ticket), and with far greater consistency.
6a) You don't have to buy just because you can afford it - You have to be very selective about the companies you're willing to buy, and even more willing to walk away from a company you love if you can't get it for a good/fair price. If it's a good company a lot of people probably know it, and in this day and age that means it's Price to earnings ratio (the price you pay for the stock divided by the earnings per share) is likely well above 30 while you're looking at it. This is where limit orders come in, find (hopefully calculate) the price you are willing to pay for a security (stock) and place your order. If the stock never hits that price fine, you've still got your cash. For example, I'm long Google (Goog) and have standing orders to pick up shares around 425. So any time Google takes a hit (please god send me another flash crash) I'll automatically buy it. While technically I keep 20 to 70% of my total portfolio in cash, the amount that isn't set aside in open bids is actually 0 to 10%. For instance, I was surprised when I woke up one day to find I owned Visa (V). I didn't think the price I set was totally realistic, but one day news was released that the government was going to cap profits from credit cards and it dropped 12% in within a day or two. My open bid triggered and I bought in, and within 3 days Visa sprang back 15%. In one day that money made more for me than a 4.5% bond would in 4 years.
6b) If you're not sure how long you should hold onto a stock or fund, hold onto it forever - If you've followed the rigorous research process I've suggested, you probably did a lot of research or had some specific reasons for buying the securities you did, so generally there's no reason to sell them unless you really need the money. If you're buying companies that you think will be doing well for 20 years, or ETFs and Mutual funds, there's absolutely no reason to sell it unless something major changes. If something major does happen, you're probably still better off not selling. Prices in the market fluctuate, and the worst thing you can do is buy high and sell low and you will be tempted to do exactly that. If you buy a stock at $100 and sell it at $50 because it pulled back 50% during a down turn you've actually lost $50 (a realized loss), but if you keep it you merely have an unrealized loss and that stock may rebound to $80 when the market stabilizes. But . . .
6c) Sometimes you've just got to pull out, or end up in a worse possition - Even if you make smart picks, sometimes the market can over value whatever it is you've bought. This is a tough call, but you might want to sell if the market's faith is too high in a stock because pretty soon that faith will fall out and the stock price will drop. To bring your attention back to Google, while I frequently buy it around $400, I also used to sell some of it around $600 when I felt the stock was being valued more than it should be. As I got more sophisticated I started buying decent companies with an edge, at great prices while they undervalued by the market. I originally thought I was going to hold Bank of America until it was $90 a share (I bought it twice, at $6 and $8 a share in equal amounts) but on April 14th 2010 I reappraised the situation and decided to sell at $19 a share, shortly after that the price dropped out (as I write this it's market price is 11.75 a share). I could tell you a similar story with MGM and CFSG. I wish I could tell that story about HOOK, which I had bought for ~$2.15/share, sold for $2.75 a share a year later, 10 days after I sold it the price broke out and ended up hitting $10/share before it began it's correction back down (to I expect $4-5). $7 to $9 a share would've been a great time to get out. Even though I spend a lot of time trying to predict the future, no one really can and you won't always call it right. Which brings me to . . .
7. When others are excited, be afraid. When others are afraid, look for opportunity.
As previously stated, our human minds are defective and ill suited for science or finance. Your largest problems will be fighting your instincts of Loss Aversion (the feeling you get that makes you want to not lose any more money in an endeavor) and Gain Hysteria (the feeling that you need to join the band wagon when a stock is rising quickly). Falling prey to those two instincts will cost you a lot of money, separating them from your other instincts (which may actually be good) will earn you a lot of money, and identifying them in others will not only save you a lot of money it can potentially earn you phenomenal returns. You will not always be successful in this. I've thrown away about $3,000 in my investment career by falling prey to these human defects, that's a lot of money just to throw away because you get caught up in the moment. Fortunately the playing field is level, and everyone else's brains also have this defect and knowing that can earn you just as much. I made 101.20% off my investment in Bank of America, more than making up for my $3,000 worth of foolishness.
8. Review your mistakes and successes, and stay diversified.
You will make good decisions, and you will make bad ones. You will lose money on good decisions from time to time, and make money with bad decisions. Regularly and critically review all the decisions that you've made and how you could have made them better as well as why you decided what you did at the time. With careful planning, solid research, and regular review you will have many more gainers than losers on a reliably predictable basis. But you'll never really know which stocks will be which when you buy them, so spread your money around. When you invest properly one investment might take a 50% hit and you'll be out $3,000 in value, but 4 other stocks probably did well enough to cover that loss and then some. Hopefully any one stock isn't more than 5% of your portfolio. Always look at the bottom line and if you had 3 losers to the tune of 3k, and 6 winners to the tune of 4k, you just gained $1,000 in value and all is well. When done properly this is called hedging and (at the most basic level) is accomplished by having a variety of investments (small cap, mid cap, big cap) in different sectors with different business strategies (growth, value, return).
9. Make investment friends
Get together with other people who are also trying to become financially secure, talk about your plans, and help each other out as much as you can. This can be as simple as talking about it over dinner, or on an internet discussion forum, to a rigorous for profit investment team.
If you would like to join my investment group, Inspired market analysis, send me a Stock, ETF, or Mutual fund pick. Let me know why you selected it, how the company or fund is positioned, your analysis of it's future, and a critique of the professional coverage of it if any. Send this to me directly, and you'll be admitted where you can freely exchange other ideas you have and critique those of other members in a constructive way.
If you're looking for a place to start, here are some of my "Shadow investments":
My benchmark ETF market tracking portfolio is even hard for me to beat at times, it's a "buy whenever and hold forever strategy". You'll never make 100% on any of these, because each fund is comprised of hundreds of great companies and they won't all do well at once but you'll probably beat your friends just by performing as well as the market over time (I try to beat the market so spend a lot of time on it, there isn't much thought needed with these funds). One thing to note is I track VFINX and SPY seperatly because VFINX was a buy and hold pre-great recession and SPY was post, but they both track the S&P500.
Here they are by how much they represented of this portfolio when I bought them:
FXI - China 25 Index Fund
VWO - MSCI Emerging Markets Index
SPY - S&P 500 Index
VFINX - S&P 500 Index
UMBSX - long-term growth of capital and income, diversified portfolio consisting primarily of common stocks
JENSX - long-term capital appreciation through consistent strong earnings and increasing free cash flow over the prior ten years
IYY - Dow Jones U.S. Index (I probably wouldn't put any money here now, I intentionally "bought" them at the 30 year low)
EZA - MSCI South Africa Index
VGT - Morgan Stanley Capital International US Investable Market Information Technology Index
DIPSX - inflation protection and earn current income consistent with inflation-protected securities
It's currently up 11.92%
As of this writing my bond portfolio is: BIV, TIP, BLV, BSV, TLT, PCY, BZF, GLD, VBMFX, HYD, MWTRX. It's up 7.7% as of right now (it's been as high as 15%) but it'll be falling as the bond market corrects to a sane level. Buy bonds when the market is going crazy, sell them in a recession.
My "Possible ideas" portfolio is currently beating the tar out of everything else at 15%, but has far too many stocks to list and most were just good buys when I was looking at them, but aren't necessarily any longer.
1a. Live in reality.
You are human, just like everyone else, inherently flawed and incapable of thinking clearly. This is not a dig, it is the reality of the human mind and cannot be helped. The one thing you can do is make the best decision it is possible for you to make at any particular time and hope that, on average, it's better than the decisions other people are making with a similar amount of information. To do this you need a system for making decisions, preferably one that focuses on things you've actually observed and facts rather than simply your gut or what your mind finds appealing. Your ego will generally make you feel your decisions are of a certain grade, so instead you must find a way to objectively measure them against others. In stocks, I feel the best way to do this is with "shadow portfolios". Whatever amount you decide to invest in real money, use a portfolio tracker such as google finance to "shadow invest" the same amount of money in good mutual funds and ETFs. I have 3 shadow portfolios: Bonds, Market tracking ETFs, and Everything I'm thinking about investing in. If my real money portfolio is performing better than all three of those portfolios I'm making good decisions, other wise I probably am not. Also don't get caught up in how much you made today, this week, or this year, keep track forever. How you do over time is what's important.
1b. Don't get shot.
Keep no less than 30 days worth of expenses (or 1/2 month's salary, whichever is greater) in a savings account. The interest rate you get on this money is irrelevant, that's not what it's for. The job of this money is to sit there for when you need it. Typically when you're closing your positions the money can be tied up in the paper work with your broker for two to three weeks and unable to be placed into your outstretched hand until that time. And if you need money chances are it is not possible for you to wait, and you can't buy groceries on the courtesy credit your broker extends to buy more stocks. In all honesty however, I primarily use a credit card for this purpose and only keep 1/2 a months salary in my checking account and invest the rest. But I have great credit, high credit limits, and get charged 5.5% APY (most people's credit cards are greater than 12% APY). In this case, I have 30 days to free up the cash to pay for those unexpected needs and since stocks are liquid I probably only need 3 days to 2 weeks to get that cash into my outstretched hand. Still, keeping a fair amount of money in a high yield savings account is a good idea.
2. Be dedicated in funding your retirement
Even if you'll never need of money (like you'll be retiring in a socialist country with a pension plan for all it's citizens), if your company provides matching funds in any amount for a 401k or 403b you are acting terribly foolishly if you don't max that benefit. If you make $100,000 a year and your company matches 7.5% of your salary you're preventing yourself from earning an additional $7,500 a year. That's free money from your employer that you're pissing away because you don't want to put 7,500 of your own money into your own savings account. That's a 100% return, guaranteed, every year by itself! Right now the government limits the amount you can personally put away to $16,500(2010) each year and you should strive to put in every penny to your retirement account. Once you've maxed your retirement contributions, you should channel as much money as you can afford to into the stock market but always something. I like to personally invest 10-20% of my income in addition to the 14% (to a max of 16,500) I put away into my 403b. That's right, I personally save at least 28% of every paycheck simply to invest. My average return is about 15%, but yours will likely differ either better or worse. So that means that if I made 100k last year I contributed $9,000 to my 403b which after one year will be worth $18,975 (total 211% gain) and I saved 10,000 for my personal investments and they're worth $11,500. In total I've avoided spending $19,000 and after one year that ends up being $30,475. That's like having an invisible man work full time for you at McDonald's who's only purpose in life is to earn you money, and he never wants anything in return.
3. Fund your kids retirement
If you have children, you should start their retirement within the first week of their birth. The United States government allows you to pay any individual up to $500 a year without filing employment paperwork with the IRS. So you should pay your child a salary for being cute & giggling (so it's "earned income") up to $500 a year and place it into their ROTH IRA (The IRA you pay your taxes on before investing it). Making only yearly $500 contributions from age 0 to 18 you will have contributed $9,000 and on their 18th birthday that retirement account will be worth ~$20,000 (a 222% increase). That money can be rolled over (I believe without penalty) into a 529 plan to be used for education if you weren't able to sufficiently fund that (but you should be doing that too if you can). If they leave that money alone, and never fund it again for the rest of their lives they'll have $671,352.82 available to them upon retirement at age 65, all tax free.
4. Keep an open ear.
If you're reading this you probably have a physical body, and if you have a physical body it is limited to biological reality and corporeal space. You simply do not have enough time or ability to do enough research on your own to be successful, you will need to get ideas from others. You may not need their advice, but you do need their ideas. Chances are if someone has suggested it to you other people are thinking about it too, so it'll behoove you to pay attention and act fast.
5. Due diligence and searching for yourself.
Any idea you get, whether you are it's originator or not, needs to be researched and tested for validity. Try to get as much information from as many different sources as you can, and as many view points. Often media, particularly American media, is a perpetual hype engine that will cheer on any container placed in front of it with any liquid in any amount. And before you buy even a single bottle of Yak Piss you should know what's in the bottle, what Yak Piss is useful for, and what sort of return you can get for it. Are you getting a fair price? Getting a shares of a Great Company (like Coca-Cola) at a decent price is many times more valuable than getting shares of a decent company at a great price.
6. Don't be afraid to walk away, cash in hand.
One of the best preforming "hedge funds" of all time had a mean ("average") of 50% of it's total assets in cash at all times, but more often than not (mode) 70% of it's total assets were in cash. Don't be afraid of cash and it's meager returns, if you invest properly your gains will blow away Bonds, CDs, Treasuries, and all other financial instruments (other than a winning lottery ticket), and with far greater consistency.
6a) You don't have to buy just because you can afford it - You have to be very selective about the companies you're willing to buy, and even more willing to walk away from a company you love if you can't get it for a good/fair price. If it's a good company a lot of people probably know it, and in this day and age that means it's Price to earnings ratio (the price you pay for the stock divided by the earnings per share) is likely well above 30 while you're looking at it. This is where limit orders come in, find (hopefully calculate) the price you are willing to pay for a security (stock) and place your order. If the stock never hits that price fine, you've still got your cash. For example, I'm long Google (Goog) and have standing orders to pick up shares around 425. So any time Google takes a hit (please god send me another flash crash) I'll automatically buy it. While technically I keep 20 to 70% of my total portfolio in cash, the amount that isn't set aside in open bids is actually 0 to 10%. For instance, I was surprised when I woke up one day to find I owned Visa (V). I didn't think the price I set was totally realistic, but one day news was released that the government was going to cap profits from credit cards and it dropped 12% in within a day or two. My open bid triggered and I bought in, and within 3 days Visa sprang back 15%. In one day that money made more for me than a 4.5% bond would in 4 years.
6b) If you're not sure how long you should hold onto a stock or fund, hold onto it forever - If you've followed the rigorous research process I've suggested, you probably did a lot of research or had some specific reasons for buying the securities you did, so generally there's no reason to sell them unless you really need the money. If you're buying companies that you think will be doing well for 20 years, or ETFs and Mutual funds, there's absolutely no reason to sell it unless something major changes. If something major does happen, you're probably still better off not selling. Prices in the market fluctuate, and the worst thing you can do is buy high and sell low and you will be tempted to do exactly that. If you buy a stock at $100 and sell it at $50 because it pulled back 50% during a down turn you've actually lost $50 (a realized loss), but if you keep it you merely have an unrealized loss and that stock may rebound to $80 when the market stabilizes. But . . .
6c) Sometimes you've just got to pull out, or end up in a worse possition - Even if you make smart picks, sometimes the market can over value whatever it is you've bought. This is a tough call, but you might want to sell if the market's faith is too high in a stock because pretty soon that faith will fall out and the stock price will drop. To bring your attention back to Google, while I frequently buy it around $400, I also used to sell some of it around $600 when I felt the stock was being valued more than it should be. As I got more sophisticated I started buying decent companies with an edge, at great prices while they undervalued by the market. I originally thought I was going to hold Bank of America until it was $90 a share (I bought it twice, at $6 and $8 a share in equal amounts) but on April 14th 2010 I reappraised the situation and decided to sell at $19 a share, shortly after that the price dropped out (as I write this it's market price is 11.75 a share). I could tell you a similar story with MGM and CFSG. I wish I could tell that story about HOOK, which I had bought for ~$2.15/share, sold for $2.75 a share a year later, 10 days after I sold it the price broke out and ended up hitting $10/share before it began it's correction back down (to I expect $4-5). $7 to $9 a share would've been a great time to get out. Even though I spend a lot of time trying to predict the future, no one really can and you won't always call it right. Which brings me to . . .
7. When others are excited, be afraid. When others are afraid, look for opportunity.
As previously stated, our human minds are defective and ill suited for science or finance. Your largest problems will be fighting your instincts of Loss Aversion (the feeling you get that makes you want to not lose any more money in an endeavor) and Gain Hysteria (the feeling that you need to join the band wagon when a stock is rising quickly). Falling prey to those two instincts will cost you a lot of money, separating them from your other instincts (which may actually be good) will earn you a lot of money, and identifying them in others will not only save you a lot of money it can potentially earn you phenomenal returns. You will not always be successful in this. I've thrown away about $3,000 in my investment career by falling prey to these human defects, that's a lot of money just to throw away because you get caught up in the moment. Fortunately the playing field is level, and everyone else's brains also have this defect and knowing that can earn you just as much. I made 101.20% off my investment in Bank of America, more than making up for my $3,000 worth of foolishness.
8. Review your mistakes and successes, and stay diversified.
You will make good decisions, and you will make bad ones. You will lose money on good decisions from time to time, and make money with bad decisions. Regularly and critically review all the decisions that you've made and how you could have made them better as well as why you decided what you did at the time. With careful planning, solid research, and regular review you will have many more gainers than losers on a reliably predictable basis. But you'll never really know which stocks will be which when you buy them, so spread your money around. When you invest properly one investment might take a 50% hit and you'll be out $3,000 in value, but 4 other stocks probably did well enough to cover that loss and then some. Hopefully any one stock isn't more than 5% of your portfolio. Always look at the bottom line and if you had 3 losers to the tune of 3k, and 6 winners to the tune of 4k, you just gained $1,000 in value and all is well. When done properly this is called hedging and (at the most basic level) is accomplished by having a variety of investments (small cap, mid cap, big cap) in different sectors with different business strategies (growth, value, return).
9. Make investment friends
Get together with other people who are also trying to become financially secure, talk about your plans, and help each other out as much as you can. This can be as simple as talking about it over dinner, or on an internet discussion forum, to a rigorous for profit investment team.
If you would like to join my investment group, Inspired market analysis, send me a Stock, ETF, or Mutual fund pick. Let me know why you selected it, how the company or fund is positioned, your analysis of it's future, and a critique of the professional coverage of it if any. Send this to me directly, and you'll be admitted where you can freely exchange other ideas you have and critique those of other members in a constructive way.
If you're looking for a place to start, here are some of my "Shadow investments":
My benchmark ETF market tracking portfolio is even hard for me to beat at times, it's a "buy whenever and hold forever strategy". You'll never make 100% on any of these, because each fund is comprised of hundreds of great companies and they won't all do well at once but you'll probably beat your friends just by performing as well as the market over time (I try to beat the market so spend a lot of time on it, there isn't much thought needed with these funds). One thing to note is I track VFINX and SPY seperatly because VFINX was a buy and hold pre-great recession and SPY was post, but they both track the S&P500.
Here they are by how much they represented of this portfolio when I bought them:
FXI - China 25 Index Fund
VWO - MSCI Emerging Markets Index
SPY - S&P 500 Index
VFINX - S&P 500 Index
UMBSX - long-term growth of capital and income, diversified portfolio consisting primarily of common stocks
JENSX - long-term capital appreciation through consistent strong earnings and increasing free cash flow over the prior ten years
IYY - Dow Jones U.S. Index (I probably wouldn't put any money here now, I intentionally "bought" them at the 30 year low)
EZA - MSCI South Africa Index
VGT - Morgan Stanley Capital International US Investable Market Information Technology Index
DIPSX - inflation protection and earn current income consistent with inflation-protected securities
It's currently up 11.92%
As of this writing my bond portfolio is: BIV, TIP, BLV, BSV, TLT, PCY, BZF, GLD, VBMFX, HYD, MWTRX. It's up 7.7% as of right now (it's been as high as 15%) but it'll be falling as the bond market corrects to a sane level. Buy bonds when the market is going crazy, sell them in a recession.
My "Possible ideas" portfolio is currently beating the tar out of everything else at 15%, but has far too many stocks to list and most were just good buys when I was looking at them, but aren't necessarily any longer.
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