Before I get into today’s post I’d like to just take a sec to provide a bit more background about this blog series I’ve embarked upon:
- Empower Yourself and Be Your Own Financial Adviser
- How to Choose the Right Brokerage Firm
- Building Your Personal Investment Portfolio
Over the past few years I’ve been approached by a number of individual investors unhappy with the cost, the results or just the process of investing with their current adviser. They don’t understand what they own in their portfolio, why they own it or why their results have been so poor for so long.
My answer to them is always the same: you have been way overpaying for a truly shitty product. The entire financial industry is set up to make money OFF of you not FOR you. So I’ve taken it upon myself to teach of few of these folks how to manage their own investment portfolios on their own the right way.
There are so many more people out there who desperately need this kind of help I’ve decided to put it all down here. I’m not making a dime from helping any of these folks or for writing this for you. But the satisfaction of seeing just a fraction of you “get it” and make this change makes it all worthwhile for me.
On to today’s topic: integral safeguards to managing your own investments. The most important part of managing your own investments is going to be discipline. Mistakes are made because investors either have no discipline or they forsake the discipline they set up in the first place.
In order for this to work you have to realize that your brain will tell to forsake your discipline at times but you need to remind yourself that you committed to a specific discipline for a very, very good reason – to prevent you from making major mistakes with your hard-earned money.
The first discipline you must implement is monthly dollar cost averaging. This is really very simple: if your account is $100,000, you will not invest it all on day 1. You will invest 1/12th ($8,333) of it every month over a period of 12 months. If you want to be more conservative invest 1/24th ($4,167) every month over a period of 24 months. And you have to do it like clockwork.
The main benefit of dollar cost averaging is that it will prevent you from buying too much of any given asset class at the wrong time. You saw how many people went “all in” to the real estate market in 2005. They didn’t do this because they were trying to lose money; they did it because their brains told them it was the right thing to do. Dollar cost averaging limits the ability of this idiot part of your brain to push you into these kinds of bad decisions.
The other benefit of dollar cost averaging is that it will ensure that you get a fair average price over your investing time frame. For example, investing $8,333 per month your purchases will get you more shares when prices are low and fewer shares when prices are high.
Once you’ve finished your dollar cost averaging program and are fully invested in the asset classes you have chosen and in the allocations you decided suit you you will need to implement a new program. Rather than dollar cost averaging every month you will need to begin the process of rebalancing.
Let’s say that you get your portfolio fully invested and a month later stocks have done great while bonds have not. As a result, the percentages you originally set up will now be skewed. If you started with 30% in stocks and 30% in bonds today it may be 33% in stocks and 27% in bonds. You will need to sell enough of your stock fund to bring that back to 30% and buy enough of the bond fund to bring it back in line.
The benefit of this kind of rebalancing is that it forces you to buy low and sell high. When an asset class goes up you sell some. When it goes down you buy a little. All in all, you end up making small changes to maintain that comfortable allocation you originally decided on.
All of these tools or strategies have one overriding purpose: to prevent you from making that one big mistake. In investing small mistakes are fine. They can be easily overcome. Big mistakes are the ones that have a major and lasting impact on your financial well-being and so must be avoided at all costs.
Most people don’t understand that if you suffer a 50% loss you have to double those funds to get back even. Don’t put yourself in that position. Commit to being disciplined using dollar cost averaging and then rebalancing and you are light years ahead of the vast majority of individual investors.