Legendary investor Warren Buffett is often quoted in the media for his fundamental tidbits of advice that work not only for him, but are widely recognized as sound recommendations for the average investor. He once said, “Our favorite holding period is forever” to indicate conﬁdence in the long-term success of the companies in which he invests. (1) While no one is likely to achieve the kind of success Buffett has enjoyed, understanding some of the basic tenets for investing can be a good place to start.
There are meticulous stock pickers, rapid-ﬁre day traders and automatic buy-and-holders — representing just a few of the many different types of investors. There are even investing styles associated with various asset classes. For example, value stocks tend to trade at a low price relative to their fundamentals (i.e., dividends, earnings and sales), leaving growth potential on the table for patient investors when the rest of the market recognizes their full value. Growth stocks feature consistently strong earnings growth over time, while income stocks provide a combination of paid dividends and long-term capital appreciation.
For an individual investor, it’s important to pair the right combination of investments with his or her ﬁnancial objectives, taking into consideration both the timeline for when money is needed and the amount of risk that is acceptable to reach the target accumulation. With this goal in mind, here are three tenets of investing that have enabled vast numbers of investors to achieve their ﬁnancial goals.
Rule No. 1: Adopt a Long-Term Perspective
Investors are likely to have a range of ﬁnancial priorities throughout their lifetime. These may include accumulating enough money to put a down payment on a house, paying a child’s college tuition and saving for retirement. While each of these ﬁnancial goals may have a different timeline, we feel it’s still important to maintain a long-term perspective when it comes to investing.
For example, if your goal is to buy a home in three years, would you invest whatever money you have right now in a super-risky investment in order to accumulate money quickly? Probably not, as you could lose that money and risk not being able to buy a house at all.
Not only should you consider how much you need to accumulate to meet a certain goal, but how you get there matters as well. Some people may wish to take higher risks while others are more conﬁdent with a strategy containing low-risk investments. Regardless of where you fall on the investment risk spectrum, sticking with your plan over the long-term may offer you the greatest chance of success.
Over time, the investment markets generally follow an upward trend. The key to Rule No. 1 is to establish an asset allocation mix designed to meet the timeline for a speciﬁc investment, and then practicing patience and fortitude until you get there.
Rule No. 2: Mitigate Risk
The ﬁrst and most signiﬁcant factor to understand when it comes to investing is that prices rise and fall. This can be a good thing, because there are opportunities to buy when prices are low, and sell when they increase; that’s how investors proﬁt. A second consideration is that a drop in stock price does not necessarily mean a drop in a company’s value. Stock prices are inﬂuenced by a wide range of market factors, from a bad product review to popular shopping trends. The underlying fundamentals of the company are generally more important than day-to-day ﬂuctuations in revenue or share price.
Yet, the fact remains that stock prices rise and fall and this in turn affects an investment portfolio’s market value. One way to manage the impact of performance declines is to diversify among a variety of different investments in a variety of different asset classes. This strategy enables investments that are performing well to offset losses of those faring poorly. While diversiﬁcation can diffuse the impact of high-performing securities, its main value is to mitigate overall risk of loss.
For example, during the 2008-09 bear market, nearly every asset class suffered varying degrees of decline. On the surface, it may have appeared that diversiﬁcation failed due to declines across the board. However, remember that performance is relative, so a decline in a diversiﬁed portfolio generally will not be as dramatic as a more concentrated portfolio. This is demonstrated in the accompanying table.
Risk will always exist; it’s not possible to insulate your money 100 percent from risk and still be considered an investor. However, the key to Rule No. 2 is to recognize what risks are important to you. For example, some investors may be more focused on risking loss of savings already accumulated, while others may be more willing to invest aggressively because their biggest fear is the risk of running out of money during retirement.
Rule No. 3: Keep Your Wits About You
Everyone, even seasoned investors, can feel angst when watching the value of their investments decline. However, the difference between novice and successful investors frequently comes down to resilience and disposition: Can you hold steady during the declines?
While past performance does not guarantee future returns of individual securities, it can be a good indicator of overall stock market performance over long time periods. For example, between 1990 and 2016, a hypothetical investment in the S&P 500 would have returned an average of 9.3 percent a year. If that investment had missed just 15 of the best days over the 26-year timeframe, it would have returned only 5.4 percent a year. (3 )
The key to Rule No. 3 is to stay the course and not let day-to-day market performance deter you from your long-term investment goals.
Warren Buffett’s conﬁdence in U.S. corporations…
“For 240 years it’s been a terrible mistake to bet against America, and now is no time to start … Investors who diversify widely and simply sit tight with their holdings are certain to prosper.”(4)
Remember that investment decisions should be based on your objectives, risk tolerance and time horizon — not on how the markets are currently performing or what your neighbor just bought. With that said, it’s important to stay ﬂexible and be willing to change your strategy as needed. Not necessarily because investment markets, tax policies and interest-rate environments change, but because things can happen in our personal lives that require us to re-evaluate our goals and develop new strategies to reach them. As always, it’s a good idea to consult with your ﬁnancial advisor before making any major changes to your investment portfolio.