Realist Principles

Each time we invest, we must be prepared to live with the consequences and hold ourselves accountable for the results. Therefore, it’s essential to invest with principles that in no way guarantee success but help avoid many common pitfalls. We recommend the principles below for all investors and readers of Market Realist.

The Realist Principles

1. Long-term investing

There is a clear correlation between the amount of trading by individual investors and their returns. For example, a team from UC Berkeley reviewed brokerage accounts for more than 65,000 US households from 1996 to 1999. This study found that the one-fifth of investors with the longest-term investments outperformed the one-fifth of investors with the shortest-term investments by 71% annually. This research team summarized, “Our central message is that trading is hazardous to your wealth.”

2. No shortcuts

There are no shortcuts to investing. It takes hard work to produce results. We know you are smart and recognize there’s no free lunch. Ultimately the most successful investors are also amongst the most-disciplined.

3. Don’t panic

The standard deviation for investing in the stock market, as measured by the  S&P 500 Index during the ten-year period from 2003 to 2012, is 20.3% annually. Therefore, investors shouldn’t be surprised when prices grow or fall rapidly. When the market hits bottom, you can buy more at cheap prices. If the market grows, this means the value of your investments increased substantially. Whatever happens, have a plan and be careful not to overreact.

4. Keep it simple

Complexity can often introduce more risks. Avoid esoteric assets such as complex stock options, leveraged funds, and foreign currencies unless you are an expert. These securities may add value for certain corporations, market makers and hedge funds. Investors who are not experienced specialists in complex securities often quickly lose their shirts.

5. Don’t invest in securities you don’t understand

Even if you’re investing in a large-cap company or major ETF, be sure to adequately research the investment until you feel confident making a decision. Market Realist tries our best to point out the key factors affecting valuations of investments; however, we should not be used as a standalone source of information to help you form investment decisions. Try to read Market Realist research and analyses. Research other investment sources and exercise your own independent judgment.

6. Don’t copycat invest; do what’s right for you

Various investment strategies involve replicating the trades of famous investors or hedge funds. It’s not always possible though to know whether the investors are betting against (or hedging against) the same company. Furthermore, investors may have acquired the security at a lower price or have a reason for buying that’s unique to their particular investment strategy. One of the reasons successful contrarians are respected is they act independently and avoid a herd mentality.

7. Be conservative

Making money is much more difficult than losing it. For example, assume you make ten investments for $100,000 each. Nine of these return 10%, and the tenth loses 100%. You’ve actually lost $10,000 plus trading fees and your time. The sting of one bad bet can wipe out all your earnings. As famous investor Warren Buffett once said, “Rule No.1 is never lose money. Rule No.2 is never forget rule number one.” Practicing conservative tactics such as diversifying your bets and maintaining a safe debt-to-equity ratio helps investors avoid pitfalls.

8. Avoid fees

Fees can have an unexpectedly huge impact on overall investment performance. For example, a single $100,000 investment over ten years with a 6% annual return and a 2% annual fee would generate a $46,000 profit. With no annual fee, the same investment would generate a $79,000 profit. That $33,000 difference is enough for a new car. Fees to avoid include unnecessary trading costs, management fees, front-load fees and differences in bid-ask spread.

9. Think for yourself

The most selling activity tends to occur when the stock market falls, and the most buying activity tends to occur when market prices increase. Herd mentality is often described as anthropologic and natural in all of us. However, to be successful investors, we must resist the urge and make decisions about the direction of the markets based on data, not on feelings or what other people say.

10. Don’t be overconfident

Skepticism is a healthy trait for an investor. When we convince ourselves that we’re right, we can be closed-minded to contradictory information that might not support our conclusions. This is known as selection bias. While confidence is important in order to become successful and follow a consistent investment strategy, it’s important to always be willing to consider relevant primary data with an open mind as it becomes available.

Finally, we urge you to heed the words of Ray Dalio, famous investor and founder of Bridgewater Associates, one of the world’s most successful hedge funds. Dalio said, “Success is achieved by people who deeply understand reality and know how to use it to get what they want.” Market Realist seeks to help investors deeply understand reality, and we urge you to heed our investment principles in exploiting market truths.