New Investing Rules

An article in the Washington Post makes the case for a new list of good investing rules for whenever the post crisis period begins. Perhaps the real answer is the old rules apply but not in the simple form most people have utilized them.

The second major point is perceiving the current environment as a once in a lifetime event. From the highs in October of 2007 to the lows in March of 2009, the market declined just over 50%. That is the biggest decline since.... well... March 2000 to October 2002. Probably not as far back in history as you thought. We also had a 50% decline in the 70's. Point is, these declines are actually normal. What wasn't normal was the above average gains achieved, especially in the late 90's. The gains in housing just a few short years ago were significantly above any historical precedent.

Buy and hold still works but not if you buy and forget. Warren Buffett encourages buy and hold but he is very particular about what to buy and meticulous about the PRICE to pay for that item. He could go years without a purchase, he sits back and waits for his pitch, that is his gift.

Warren Buffett would be the first to tell you that he wishes he had sold at some of the insane valuations experienced in the 90's. Buy and hold doesn't tell you when to sell, but you can't spend an unrealized gain so at some point selling has to be a part of the equation before you can declare victory.

Risk Tolerance - most people do underestimate their risk tolerance and it is times like these when they realize that (and of course it is too late by the time they realize it). When the market is going up compare your gains to that of the S&P. If you are earning significantly more than the market average, you may be assuming more risk than the market. Even if you seek to achieve the same returns as the market in a given year you have to understand the history of the market which as mentioned above includes some very steep declines.

You will generally hear statistics that say the market has averaged 8-10% per year over long term periods. But what this stat doesn't tell you is that it is actually very unlikely for the market to return 8-10% in a given year. You are more likely to have 15-20% gains balanced with years of declines of 10% or more. Sure the long term average smoothes out to a nice 8-10% but the short term volatility can make a huge impact on your perception of risk tolerance.

Market Timing - people like to lead you to believe that not only is it impossible to time the market, it also carries with it a certain negative conotation for those that attempt to game the market. Market timing is not about being perfect. You do not need to catch the exact top or the exact bottom to be successful, it's okay to be early. If you had sold off your stocks at any point in 2006 0r 2007 you would have the opportunity to get in now. Whether we have hit a bottom or not, there is less risk when the market has just declined 50% then after a huge run up.

Dollar Cost Averaging - brokers will usually prefer the invest it all at once strategy because unless it is a fee based account, there is no commission until the funds are invested. It is still a good strategy to work the money in but it doesn't necessarily have to be so systematic. You can set up a system that allocates a monthly investment but keep some behind separately to take advantage of an above average sell off.

Most importantly, do your homework, look at the historical results of the markets. Most investors look at the opportunity and try to figure out how much they can make. The more important question is how much are you willing to lose, how much volality can you handle? You don't need a plan for if you make more then you thought, but you do need to focus on the downside and the worst case scenario. A best case scenario will take care of itself.