Investment principles are the foundation of a successful portfolio management strategy. Too many investors put together a collection of assets without a portfolio management strategy guided by investment principles.
The following investment principles will guide your portfolio management toward strategies that improve the probability of above average returns.
1. Do It Yourself, But Not By Yourself
The benefits of self directed investing are numerous. It has never been easier to manage your own portfolio. Because of technology everyone has access to investment information and can execute transactions at record low prices. There are many resources, such as my Asset Allocation Model Investing Guide, to help you stay in control of your assets.
2. Know What Kind of Investor You Are
Most people consider themselves to be one of two types of investors. But I add a third type that few investors would admit to being.
A passive investor is willing to accept an average rate of return and invests mostly in index funds. An active investor believes that valuation should be taken into account and will own more of an asset when valuations are low and less when valuations are high. I add a third type of investor, the one who doesn’t know what type of investor they are. These investors buy high and sell low because they allow their emotions to affect their investment decisions.
3. Understand Basic Investment Concepts
There are basic investment concepts all investors should know. The importance of time, preservation of principal, risk, risk management, and asset allocation are critical concepts investors need to understand. Make sure you understand the basics before you invest your money.
4. Keep Expenses Low
High expenses do tremendous damage to portfolio values. Choosing the best investment vehicles is the first step in keeping expenses low. The mutual fund expense ratio is notorious for sapping an investor’s returns.
One percent can make an unbelievable difference. A $100,000 investment for 30 years at 6.5% grows to $699,179. A $100,000 investment for 30 years at 5.5% grows to $518,738. In other words, if your expenses lower your return by just 1%, you make $180,000 less over 30 years on a $100,000 investment!
5. Have a Maximum Drawdown Plan
A drawdown is the amount, usually expressed as a percentage, your portfolio declines from a peak to a low. The biggest risk of investing is losing your principal. Once you lose your principal that money is no longer available to grow and recoup your investment.
If you experience returns of +50% and – 50%, you are not at break even but have lost 25% of your portfolio. This is why it is important to implement portfolio risk control strategies.
The Importance of Portfolio Management
These 5 investment principles are a solid foundation to get your portfolio management strategy started. Many investors pay too little attention to portfolio management in favor of stock selection. It is your portfolio management strategies guided by investment principles that will provide the greatest returns for your time.
Additional Reading: Asset Allocation for the Value Investor