The real secrets to investing success won’t make you rich overnight, but they will boost your long-term portfolio gains
Investing has its own set of laws, but they are different from the laws of the physical world. In fact, they are more like certainties than laws—they always apply in the end, though at times it may seem they’ve been suspended or repealed.
You can enhance your long-term investment results by following these laws—what we call our seven secrets to investing.
Learn everything you need to know in '9 Secrets of Successful Wealth Management' for FREE from The Successful Investor. Secrets of Successful Wealth Management: 9 steps to the life you've always wanted, before and after retirement.
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Learn everything you need to know in '9 Secrets of Successful Wealth Management' for FREE from The Successful Investor.
Secrets of Successful Wealth Management: 9 steps to the life you've always wanted, before and after retirement.
These seven secrets to investing are important truths
- Most people understand that compound interest—earning interest on interest—can have an enormous ballooning effect on the value of an investment over time. Instead of steady returns, compound interest gives you an increasing rate of return, based on your initial investment. However, it’s less widely recognized that the compound interest principle also works in reverse.
Every fee you pay reduces the funds you have available for re-investment, and re-investment of capital is what makes compounding work the way it does. So, you need to pay attention to steady drains on the capital in your portfolio, even seemingly small ones.
Key point: In any financial transaction, question the fees. Find out if they are negotiable, or at least competitive. Determine for yourself if they are worth the expense. Excess fees can eat up a surprisingly big chunk of your portfolio in a decade or two. They can deflate the compounding balloon.
- Regression to the mean is inevitable. No investor and no investment can earn an outsized return indefinitely. Eventually, a high yearly return will come back down toward average. Sometimes, it will fall until it drops far below average, or turns into a loss.
Key point: Don’t buy a stock just because it’s going up, and don’t follow an advisor just because he or she has had a great year or two. You have to look deeper to spot good investments and good advice.
- No investment can ever be so attractively undervalued or desirable that it overcomes a lack of integrity on the part of company insiders. There’s no limit to the number of ways that unscrupulous insiders can cheat their investors.
Key point: If you have any doubts about the integrity of insiders, sell immediately.
- As a group, investment long shots are invariably overpriced. If you have nothing but long shots in your portfolio, you are likely to make meager returns over long periods, or lose money. That’s why you need to be particularly cautious and selective when adding anything to your portfolio that offers the potential of high returns.
Key point: If you feel you must own risky and speculative stocks, ensure that they make up a small part of your portfolio, if any.
- Financial incentives have an enormous impact on the beliefs and behaviour of otherwise honest people, particularly when it comes to what they will say to spur you to buy something.
I’m not just referring to stockbrokers. I’m talking about human nature. As the saying goes, never depend on your barber to admit that it’s too soon for you to get your hair cut. For that matter, if a surgeon advises you to undergo surgery, get a second opinion, but not from another surgeon.
Key point: To succeed as an investor, it’s essential to stay alert for conflicts of interest. Failing to do so can devastate your long-term investment returns.
- The markets for widely traded goods like oil, foreign exchange, U.S. government bonds and gold are inherently unpredictable.
Markets like these are so enormous that there is no practical limit to how much you can trade in them. It follows that if you could predict them, you could wind up acquiring a measurable proportion of all the money in the world, and nobody ever does that.
Key point: It’s a mistake to build your portfolio in such a way that you have to do the impossible such as accurately predict the future direction of widely traded goods like oil, interest rates or gold. You’ll have heavy losses with every prediction that fails.
- In any reasonably healthy economy, equities will always give you a higher return than bonds over long periods. There’s a self-regulating mechanism at work that guarantees this. If it didn’t work that way, everybody would prefer bonds (with their predictable returns) over stocks (which have variable returns). Bond prices would then rise, interest rates would fall down toward zero, and virtually all corporate profit would flow to stockholders.
Key point: Invest in bonds only when you must have steady returns, or when interest rates are unusually high. The rest of the time, you’re better off in stocks.
Have other so-called investing secrets led you to make poor investments?
Have you been enticed by investing secrets that offered overnight success only to find they were impossible dreams? What was the giveaway?