Got Principles?

by Rob on November 7, 2011

Successful investors all have one thing in common — a solid set of principles that allow them to (a) effectively build wealth over time with their at-risk capital and (b) avoid the emotional ups and downs that invariably come with being an investor.  Adopting good investment principles is perhaps one of the “biggest rocks,” and very importantly, having such principles is completely under the control of the investor (as opposed to the short term vicissitudes of the capital markets).

Author and financial industry speaker Nick Murray suggested some key principles in his book Behavioral Investment Counseling that I believe are highly effective — and would like to share.

First what exactly are principles?  At root, they are an attitudinal approach to investing that exists in the mind of a long-term investor.  Principles are foundational in nature, and lead to effective investment practices — in the same way that belief leads to action.  As a good set of core principles differentiate the most successful investors, here are some principles to live by:

Optimism.  Successful investors have faith in the future, and conclude that it is more powerful to bet on economic global success than crisis or failure.  They adopt this perspective because it is the worldview that best aligns with the historical record.  This long-term optimistic perspective is held not in spite of the facts, but as a conclusion from them.  They understand that competitive economic market forces are going global and quickening the pace of economic growth.  Even though the U.S. economy may be challenged in the short-term, these forces will likely to accelerate the arc of human progress over the long-term.

Patience.  Successful investors also demonstrate patience.  A patient investor does not feel compelled to react or to make changes to her core investment approach when faced with challenging economic times — such as the times in which we now find ourselves.  Having patience represents a refusal to react inappropriately to disappointing events.  Instead, patience is a principle that invokes a decision not to do something wrong.

Discipline.  Not the least of Murray’s three principles is discipline.   Discipline in many respects is the flip-side to patience.  A disciplined investor has a determination to keep to her core investment practices in the face of challenging economic circumstances.  Discipline, therefore, is the active decision to keep doing the right things.

These core principles provide the fundamental emotional intelligence that distinguishes the most successful investors.  When combined with effective investment practices, they provide a powerful framework for long-term, goal-based wealth creation.   Investment practices are the actual methods used in portfolio management — and are where the rubber hits the road.  The following practices have proven their worth over time and are ones that I highly recommend.  In future posts, I will share why these practices are so effective:

Diversification by asset class.  Diversification by asset class refers to the thoughtful selection of assets with which to create an investment portfolio.  Prime examples of asset classes include fixed income (including bonds and cash equivalents), equities (including domestic, international and emerging market stocks), and Alternatives (such as real estate, commodities and natural resources).  Because of the fundamental economic relationship between risk and return, to an overwhelming degree, an investor’s selection of asset mix has the primary impact on that investor’s long-term investment returns.

Diversification by security.  Once a “policy decision” is made as to asset class allocation, successful investors further
diversify within any one of those asset classes.  This is different than diversification by asset class, which speaks to the allocation of a portfolio among asset classes.  Diversification by security selection speaks to the approach of making broad investments within each one of the selected asset classes.

Rebalancing.  One final practice of successful investors is to periodically rebalance their portfolios back to the asset allocation that they have intentionally set.  This practice both keeps a focus on the intended allocation, and returns the portfolio to a allocation that provides the most appropriate balance of risk and return.

Although these principles and practices are definitely “big rocks” when it comes to long-term, successful investing — they are sometimes forgotten by investors.  Most often, this forgetfulness occurs during stressful economic times.  It is during such times that it is important to revisit your core principles and to re-affirm your practices.  Such a habit will certainly prove supportive to your long term financial success!

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