By: Tim Fortier — January 6, 2021
Kick off the New Year With the New Rules of Investing
Happy New Year!
As we welcome in the 2021, (and kick 2020 deservedly to the curb)...
I thought it would be fitting to start the year
with a series of weekly articles designed to get you off to a solid start.
This is the time of year that many of us make some type of resolution to improve one or more aspects of our life.
(Click any image to enlarge)
(Money and health are among the most popular types of New Year's resolutions.)
Despite ever-changing markets, and new academic research, and advancements in finance and technology, (the fintech revolution)...
Nearly all personal finance advice is pretty stale.
Almost every personal finance "expert" will tell you how you need to "spend less and make more" to be rich.
Really Einstein? Thanks!
And when it comes to investing, most of these so-called "experts" will say something like "invest in your company's 401(k) plan", "buy an index fund", and "don't forget to keep six months of expenses in emergency savings".
You’ll do slightly better than average if you follow this advice, but in personal finance "average" still sucks.
What investors need is some fresh advice, and here it is. I call it The New Rules of Investing.
In short, these new rules represent a modern investing framework based upon the latest research.
And, importantly, it is outcome-based and easy to implement.
Establishing a Framework
At the core of everything I do... whether I am working with individual investors, financial advisors, or institutions... sits this concept of a rules-based investing process.
I sometimes refer to it as systematic investing. It's really all the same thing.
Rules-Based Investing is the process where ALL investment decisions are made via “pre-established rules” that clearly define the what, when, and why for buying and selling an investment.
It’s an approach that relies on “observable” and “verifiable” evidence between the data used to make decisions and the desired outcome.
Before getting into the details, you need to understand WHY this is so important for growing your wealth.
For years, studies, such as DALBARs "Quantitative Analysis of Investor Behavior" (QAIB) report, have consistently shown that investment results are dependent on investor behavior.
Those studies also show that investors meaningfully underperform the benchmarks due to poor investing practices.
A recent study (referencing investment returns from 1989-2019) shows that the average investor in an asset allocation fund (a mixed portfolio of stocks and bonds) earned only +2.29% during the 30-year period in question.
Meanwhile, a portfolio that was 60% in the S&P 500 index (stocks) and 40% in the Barclays Aggregate Index (bonds) earned +8.34% over the same 30-year time frame. That's a gap of more than +5%!
One of the benefits of using a system is that it can help override human emotion and improve upon realized returns.
One of my favorite books is Atomic Habits, by James Clear.
The premise of the book is that we are all the sum total of our habits. Even small changes in our habits, cumulative over time, can lead to profoundly different outcomes.
In essence, we become what we practice. This is very exciting. Because it means that our reward is as much in the "doing" as it is in the "getting".
Here are some great insights from the book.
“Goals are good for setting a direction, but systems are best for making progress.”
“You do not rise to the level of your goals. You fall to the level of your systems.”
Although James was not writing an investment book, the advice given is certainly applicable to investing.
Investing without a system is like a pilot trying to fly a plane without a navigation system. Maybe the plane will reach its destination. But the chances of doing so are greatly diminished.
I believe that an investment system must meet the following criteria:
- It must be easy to follow
- The system itself must be predictable
- The system must provide measurable results in line with some desired outcome (our financial destination)
The "easy to follow" aspect is important because it's important to minimize any obstacles that might get in the way of success.
Most habits are nothing more than a choice between pleasure and pain. If the "pain of change" is too great, then the likelihood of continual practice is reduced.
This is why gyms and health clubs (remember those?) are packed in January but back to normal by mid-February.
Fortunately, anyone can become a better investor.
It simply requires the desire and some mental sweat (the ability to learn something new).
I have written about systems recently and the need for predictability. We cannot control or predict what the markets will do in the future.
But we can invest with 100% predictability when we use a proven framework that uses a consistent process.
This is a powerful concept because it means that you are in total control. Not the markets. Not politicians. Not Wall Street.
It bears repeating: it's essential that the system we use is consistent with the outcome we desire.
I find most investors want to (a) miss the big bear market declines that can wipe out years of accumulated capital... And (b) keep up reasonably close when the markets are rising.
The laws of math teach us that if losses are kept small, we need smaller gains to attain financial goals because the math of compound returns will work in our favor.
An investment approach that brings investors on a wild ride will likely lose a few passengers along the way.
Unfortunately, commonly dispensed investment advice ignores risk management to the peril of investors.
Over the course of the next few weeks, I will be introducing new frameworks as well as exposing a few of the myths that are often commonly associated with investment advice.
I will leave you this week with a final quote from James Clear.
If you want better results, then forget about setting goals. Focus on your system instead.
Happy New Year!
Editor, True Market Insider