One of the common investing rules you are told often is ‘No Risk, No Gain’. I contend that there is something more important. We call it – ‘No Rules, No Gains’.
We have behavioural issues too.
We look for information that confirms our existing beliefs. We have little interest in the Truth.
We tend to fall in love with what we own, investments included.
Sunk cost fallacy makes us hold on to our losers. We sell too late.
We bail out of our quality investments at the first sign of ‘gain’. We sell too early.
We know compounding works but fail to put it into action. In fact, we mess it up.
And many more…
While you might be taking risk, a suboptimal behaviour gets you less than what you can.
And then we set out to blame everything, everyone, except….
To succeed in investing is not easy, not without investing rules
Our constantly ticking brain forces us to act in ways that can be potentially harmful. You end up taking risks in desire of more gains but without managing the risks, we cannot turn the risks into gains. Not done right, you might even succumb to risk.
To make the most of the risk, your saviour is a very simple “set of investing rules”.
Rules reduce the burden of decision making on the mind.
In fact, some of the best professionals use a set of rules to ensure that they don’t fall prey to the machinations of the mind and act in accordance with what is best for a given situation.
Investors are no different.
Let’s look at one of the dilemmas of an investor.
The current markets are believed to be expensive based on PE or Price Earnings ratio.
This information is making several investors scared, including you. There is this lingering thought at the back of your mind as to what to do? Continue to invest, hold or exit?
There will always be situations like these which you as an investor have to grapple with. It could be about individual stocks or a mutual fund that you may hold.
In my view, the way to handle all these situations is by having some key investing rules in place.
A simple example is that of a mutual fund. Your fund manager defines some rules for the portfolio. The limits of exposure to one stock or bond or the key selection criteria prevent major mistakes as well as any significant downside in the portfolio.
What are the rules you can follow as an investor?
The rules are the best bet against your hyperactive mind. They keep you and your brain in check and let your portfolio do its best.
Here are few rules you can use as an investor.
- How much to invest in equity – I prefer to invest in equity only those monies that I don’t need for at least the next 3 years, preferably 5. You may define your own rule. A corollary: As soon as I reach a point where I need the money in the next 3 years, I shift my investments from equity to safer fixed income investments. To have the money available when it is needed is more important.
- Asset allocation – For most investors, asset allocation is the best form of risk management they can do. You can’t control markets but you can control how much you invest where. Once again, define what proportion of your investment will go where. Also define a tolerance level. In my case it is +- 10%. Then on a periodic basis, rebalance your investments to move out from the overweight ones (those crossing the tolerance limit) to lesser weighted ones.
- When to sell / exit – Selling is not an easy decision. All our behavioural biases come together and freeze us. You fall in love with your investment. You start counting the money you have already invested (sunk cost). No timely action and you may end up losing everything. The only saving grace here is a rule that tells you “sell / exit when this happens….“
There are 2 further rules that I personally follow and you may like to as well.
- Learn – Yes, you have to set rules to learn too. You see otherwise you will never do it. There are some fine minds out there sharing their knowledge and wisdom with other mortals like us. The internet has made it possible to access it and imbibe some of the best ways to manage our minds and our money. Here are some of the books I recommend. Warning: Don’t read financial porn.
- Pay yourself first – This can be easily called the first rule of investing. It doesn’t mean paying rent and grocery bills but to invest in long term investments. Define a %age of your income that must go towards such investments. How about starting with 50%?
The is by no means an exhaustive list. Define your own rules and write them down. This enables you to curtail the noise and make the most optimal decisions even in the face of uncertainty.
Remember, “NO RULES, NO GAINS.”
Will you share with me your investing rules? The comments box is waiting.
[…] course I ignore sunk costs. I’ll prove it to you after I finish the Ph.D dissertation I’ve been working on since […]