7 “Back to Basics” Investing Principles


With market turbulence at a high right now, I thought it might be a good idea to review some fundamental investing concepts to help us weather the storm. If our reaction is “the world is ending, run for the hills,” then frankly I am not sure aggressive investing is a good fit. But, if you can take things in stride and maintain a balanced approach, then read on.

First of all, there are certain things we should consider before plunking our hard-earned money down on any equity. This can include things like the price to earnings ratio, how the company does dividends, long-term strength outlook and trends in earnings growth.

In the hustle and bustle of daily life and watching the markets, we can lose sight of the fundamentals of building wealth. Before we do more complex trading, ensure the basics are all covered in terms of building long-term wealth. Here are 7 I like to revisit often.

1. Asset Allocation

Never forget to look at your portfolio of assets as a whole and determine what percentage is in the various asset classes. Is it an effective allocation? Take a step back. How do you divide your portfolio among different asset categories? This may be the biggest determinant of your investment returns. I find this is where many investors fail because they put little thought or effort into their asset allocation strategy.

Most people have a portfolio that does well in good market times and does poorly when the overall market goes down. Think about overall portfolio construction in terms of what percentage of the following you may hold:

Stocks (equities), and within this category what percentage is allocated to small caps, mid caps, large caps? How much are growth vs. value stocks? How much is international, tech, industrial, consumer staples or discretionary?

Bonds (fixed income), what are the quality of the bond ratings? Is the fund sufficiently diversified? How much to allocate to bonds typically depends on risk tolerance and age. Bonds are a lending asset vs. ownership. You are lending your money to an entity to do something, and the issuer returns a fixed percentage back to you over time. As interest rates increase, the value of the bond decreases inversely by the same value.

Cash, how much is being held in cash? This is typically rainy day emergency money or money that sits waiting for big investment opportunities.

Alternative assets: Gold or Crypto can be considered alternatives and generally riskier, but could have a small place in a well-balanced approach.

Hard assets: real estate is an example here of an asset that is tangible and manageable. Is there a place for these kinds of assets?

2. Consider Margin of Safety

If you buy an asset for less than its real value, then you have created a margin of safety. For many assets including equities of well-tracked companies, real estate, etc. there is an ability to appraise a fair market price for the particular share of the asset. Think about if you are buying the asset at a fair price, near the top, or getting on one some discount? We do not always know, but if you do some research and due diligence, for many assets we can get a sense. Papa Buffett always says Price Matters. That is the key to traditional value investing. The best plan to lower risk is to buy investments at a price that is lower than the real or intrinsic value. Price is what we pay, value is what we get.

3. Diversify Strategically

Strategic diversification delivers enormous benefits. It can be quite hard for example to pick individual stock winners in competitive industries. But we still may want to capture gains in particular thematic areas. This is the main reason I choose many thematic ETFs. I am not saying to randomly diversify, I am saying be thoughtful about overall portfolio construction. If heavy in growth tech, perhaps add some value ETFs. Try and add some uncorrelated assets. Perhaps some crypto is a good place to diversify into uncharted territory?

Both under diversification and over-diversification are common mistakes made in portfolio management. Most studies show optimization occurs somewhere between 15 and 30 individual investments. I have found beyond this becomes too much to manage and may provide diminishing returns. I like to have some classic plays like a solid S&P dividend ETF (my favorite is VDADX), a bond fund and a few core holdings that I do not touch. I pad this with exposure to sector ETFs and some individual stocks that I believe are good mid-term plays. I sprinkle in 2–3% crypto, 10% REITs and Real Estate, 10% international and I have diversified pretty well.

4. Invest For the Long Term

Yes, I like to take 5% of assets and make short-term trades. But 95% of assets are in investments. Effective investors realize if you buy an investment at a favorable price it may take time for the market to recognize its true value.

Long-term investing is one of the most important investing principles because short-term trading usually leads to poor long-term performance. This is common because many investors let fear and greed cause them to make bad decisions. The long term will take care of itself if you make wise investment decisions.

5. Keep Expenses Low

Most investors don’t realize how much difference high expenses make to their portfolio. Take a look at what happens to your returns with a 1% higher expense ratio; On a $100k investment over 30 years, a .4% expense ratio vs. a 1.4% ratio, seems like only 1%. It adds up to $146k lost in fees!!!

The bottom line, over a 30 year period, an increase in expenses of 1% can cost your portfolio dearly.

6. Do Not Forget About Compounding

Compounding is a powerful financial concept. I specifically like the power of dividend growth compounding. Basically, every dollar made over time that is reinvested makes even more dollars. Make sure you enable DRIP (dividend reinvestment in your brokerage for dividend stocks and ETFs).

7. Anticipate Market Volatility and Use Risk Management

Markets are typically manic-depressive. One day up, one day down and on and on. You can control your portfolio volatility, but you cannot control the inevitable volatility of investment markets. Therefore, you should be prepared to take advantage of investment opportunities. At the same time, you need to be cognizant of overvalued assets and be willing to move to cash when conditions are unfavorable. Admittedly, this is not easy, but with a sound approach, it can be done in many conditions.

Manage Your Own Destiny

There are all kinds of investment advisors out there that will lead people astray. We need to educate ourselves and take charge of our own financial situation. And this is not easy in a sometimes confusing environment with a lot of noise. We want to be less noise and more signal.

Technology and the internet have brought down transaction costs and provide the means to get information and guidance at a very low cost. There has never been a better time period for the self-directed investor who is willing to put a little effort into investing.

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