When making investment decisions, how do you come up with your own investment philosophy? Do you just check off the box for whatever seems to make sense at the time? Let’s take some tips from some well-known investment icons:
Buffett and Bogle
Warren Buffett and John Bogle are two of the most successful and well known investors of our time. You could summarize Buffett’s investment philosophy as invest in what you know or invest in what you like. There certainly is truth in that. The flip side of this advice might be if you don’t understand an investment then it should be avoided.
Additionally, you might want to diversify (this is one of those buzzwords financial advisors love to use) beyond stock in your 15 or 20 favorite brands. That is where Mr. Bogle comes in. He founded the Vanguard Group, which sells many low cost index funds that offer diversification to investors like you and me.
Why All the Talk About Diversification?
You may have heard about diversification and the fact that its important. But what does it really mean? Basically, it’s not having all your eggs in one basket. The thinking behind that is that you can’t be certain that any single investment will do well. Even very sound companies can run into trouble from time to time. If you have a variety of investments, they are unlikely to all tank at once. You might think of it this way: if your investment ship sails into a storm, the vessel will experience less rocking (and less sea sickness for you) if you investments are diversified.
A quick aside, if you are curious about investment terminology, Investopedia is a wonderful resource. They will even email you an investment term of the day so that you can build your technical vocab!
Beat the Market and Invest like a Monkey
The title of this section comes from the fact that active managers generally do NOT outperform the market over the long term. The promise of high investment returns is very rarely sustainable. If a manager shows a strong track record, it might just be from luck–like a monkey picking stocks by throwing a dart. So why pay active managers for nothing (they cost more) and buy the market (aka passive investing) in the form of an index fund? This is the case made in the classic book A Random Walk Down Wall Street. I steer my clients away from market timing and active management. After all, none of us has a crystal ball.
Disciplined investing has proven to be successful over time and an investment policy statement is one tool to help you do just that. It outlines the purpose behind your investments and the reasons why they were chosen. It also helps you plan for potential fluctuations in the market and know when it is appropriate to sell some of your investments.
Isn’t there more to it?
Yes. The philosophy of investing is an entire field so it is no wonder there’s more. For example, tax efficiency is another important component to investing effectively. It can be more tax efficient to put certain types of investments in certain types of accounts depending on the tax treatment of both the investment and the account. One example is placing income generating investments, such as bonds, in retirement accounts.
For more information on investing basics, login to SaveUp and watch the webinar titled “Investment Foundation.” You can also take a look at our blogpost for investment tips from Warren Buffet himself.
This post was written by SaveUp’s personal finance contributing writer, Catherine Hawley, CFP®.