Investing Basics

Investing 101: Understand These Trading Truths

The investing world is full of sampler-worthy axioms masquerading as strategies. But for any real strategy to be successful, it must have an underlying philosophy in which you can believe (this is true in sports, military campaigns and especially investing).

Investing 101

While your philosophy may include some commonly held beliefs about investing, it shouldn’t be based entirely on them. Why, you ask? After all, investors have been following them for years. The simple reason is that they may or may not be true.

Let’s take a look at some commonly cited nuggets and see if they are worthy of inclusion—or at least consideration—in your investment philosophy.

Meeting long-term financial goals is more important than beating a benchmark

I believe this is the most important truth in investing. Managing a portfolio to a benchmark is like writing a novel to a word count. It may be simple and expedient, but it’s also shortsighted and incomplete. Managing your portfolio to meet your long-term financial goals is the only strategy that makes sense.

The market will always come back

The market may indeed come back, but recovering losses from a major downturn may not occur in your investment lifetime (just ask a Japanese investor who overcommitted to Japanese stocks). Diversification and managing risk are key elements in portfolio management. Minimizing the impact of large downturns in the market is the best way to help ensure you achieve your long-term financial goals.

History repeats itself

Mark Twain once said that history doesn’t repeat itself, but it sure does rhyme. That’s why it’s imperative to stay on top of global geo-political, socio-economic and market events. These may cause the market to act in a similar fashion to what it has in the past. When it does, being able to understand trends and act prudently can help smooth out market bumps caused by major events.

The market is always efficient

This belief may have been true before the advent of flash trading, hedge funds, and dark pools. Now, it’s much more difficult to determine whether a change in the price of a security is due to high-frequency trades or a real change in the underlying value of the company the security represents. Exploiting these market inefficiencies is extremely difficult at best, but recognizing that at times security prices do fall out of line with reality is important nonetheless.

Diversification isn’t everything, it’s the only thing

Diversify or die (your portfolio may perish if you don’t). When it comes to portfolio construction, true diversification must be across individual securities, asset classes, industry sectors, geographic location, etc. The ultimate goal is to have a portfolio comprised of diversified assets that are, for the most part, non-correlated to help control risk and produce better returns.

The market is random

It is true that the market in general is random, but trends (sometimes long-term) do occur. The ability to identify and understand these trends is critical to long-term financial success. It’s important to note; however, that even when attempting to take advantage of long term trends you should manage your portfolio with an eye toward controlling risk. The markets have a nasty way of surprising investors.

Timing the market is the key to success

A wise man once said that the key to successful investing isn’t timing the market but rather time in the market. Constantly moving money in and out of the market in an effort to capture gains and avoid losses is folly (if you invest with a broker it can also cost you a bundle in commissions). Constructing a globally allocated and truly diversified portfolio is the best way to invest successfully for the long term.

Conclusion

These common beliefs are meant to be illustrative and may not represent your personal conviction or values when it comes to investing. The point is, an investment strategy is only as strong as its underlying philosophy. So when you begin to invest, it’s important to come up with a core set of principles you believe in and stick with them. If you do, the resulting strategy is likely to be successful.

= = =
David L. Blain, CFA, is chief executive officer of BlueSky Wealth Advisors, LLC, an independent registered investment advisor (RIA) doing business as D. L. Blain & Co. in New Bern, North Carolina and Pleasanton Financial Advisors in Pleasanton, California. You can contact David at davidblain@blueskywa.com