How To Invest Money - 10 Rules of Thumb for Individual Investors
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Walk in the money for the rest of us. This is a personal financial on money. How IT works, how to invest IT in, how to live without worrying about IT.

I'm your host, David stein. Today is episode four fifty four. It's title how to invest money, ten investing rules of them.

In early twenty twelve, right before I was going to leave my investment advisory firm, I spent a couple weeks in southern mexico in the u. katon. I went by myself, and I spent the time taking photographs, writing, thinking.

One of the things I was really focused on putting down my investment, as IT would apply to individuals, i'd spent almost fifteen years managing money for institutions, university and downtown private foundations, as well as managing the assets for individual investors, the assets of financial advisers. I hadn't thought much about this. Writing eventually became a book until this past week, and and turns out i've touched on some of these principles in the podcast.

I certainly discuss them, some in my book, money for the rest of us. Ten questions to master successful investing, but they are somewhat different. I thought I would be helpful to share these investing rules of thun and expand on them a little bit.

Might have changed in the past decade because things do change. Markets evolved. Economies evolve to loom.

Where I spent a week on the beach I decade ago and twenty twelve, I spent about IT just take under two hundred dollars a night for a little CBA on the beach. Beautiful, beautiful beach. IT was difficult to get to to lum at that time.

I run at a carbajal ET to drive an hour. So from cancer. Now apparently delta has a direct flight to the loom in the same hotel, or kaba, where I spent, listen, two hundred dollars a night.

Last time we checked, they wanted over fifteen hundred dollars a night per room. And we don't stay there anymore, just not worth IT to. Things evolve.

Here is investment rule. Number one, stop using institutional hammy downs. When I was going up, I got a lot hemmy down clothes for my cousins. Some I love at a killer pair of red bell bottom pants that I love to wear, but others I just sort of hid away in the door.

As individual investors, we also inherit hammy downs, not hammy down close, but tools and language that institutional investors such as pension plans and college and down's used to manage the portfolio. They include complicated tending tools such as strategic acid allocation, money color simulation, market benchMarks. Some of the tools can be helpful, but we need to remember that our individual investors were not pitching plans.

So we don't have to invest like them nor do we have to use the same tools that they use because there's a main difference between us and an institution. Ecological, we die. Institutions don't or usually don't.

The investment time arizon for an institutional investor is significantly longer and that of individuals. Most institutions invest for perpetuity, and given their longer time horizon, institutions can afford to make mistakes because there's ample time to recover from them. But as individuals, we don't get second chances.

Institutions do. If an institution, such as a pension plan or collagen, damon's suffers devastating purfoy losses, they can go to their corporate sponsors or the fund raising ARM to get more funds. But as individuals, if are approaching retirement, we don't have that luxury.

My cousins hand me down clothes worked for me because they actually fit. But in many cases, the language and tools of institutional investors don't fit individual investors wearing hammy down shoes that are too big as risky because you could trip and fall. And likewise, individuals who manage portfolios using ill fitting tools put take on too much risk.

And here's an example. Risk for an individual is the probability of losing money or running out of money completely. If you have a shorter time frame to recover from losses, no one will come to the rescue and make you whole.

And as a result, losing money can be very risky. Most institutions don't define risk as losing money, but as volatility. Volatility measures the range of expected returns for given portfolio or as a class, such as dogs or bonds. In other words, how higher the highs compared to how lower the lows as a glasses with a wider range of potential returns, bigger swings up and down or more risky, defining risk as volatility instead of losing money might seem like a small difference, but it's not that definitional difference can lead to a cade of inappropriate portfolio sions that ultimately could jeopardize a person's ability to retire.

How could that be? Because defining risk as violation link assumes that period episodes of large portfolio losses are necessary in order to meet long term investment calls, but they're not you don't need to lose a turn of money in order to make money. In fact, it's easier to make money and meet our long term goals if we can avoid major drawdowns, something we talked about a couple of weeks ago in discussing volatility drag in the episode when we talked about how much to allocate the stocks.

So institutions believe large losses are just a natural part of investing, so they minimize risk, not by reducing the chance of losing money, but by choosing a portfolio mix that minimizes the portfolio swings, given the return they're willing to suffered through large losses while at hearing to their target portfolios because they believe the bad years will be more than offset by the good years. And if they are not, they can always go raise more money. The bottle line, as individuals can't afford to lose large amounts of money when they invest.

So they shouldn't use hammy down institutional tools that encourage you dead leader s to investment rule number two, stay close to home base in investment room. Number one, we reviewed why individual investors shouldn't use institutional hammy downs to manage their investment portfolio. And IT comes down to risk, risk for an individual losing money, which can be devastating if the loss is a large, and losing large amount of money can make IT very difficult to meet our savings.

School need to remember that definitions drive behavior. If we define risk as volatility, that leads to certain investment decisions. If we define the risk of losing money, the investment decisions will differ.

In the childhood game tag, there is something called a home base where you're safe from being tagged. And in a typical game, if your tag somewhere away from home base, you become IT and you start chasing others and try to tag them. But what if, if we were tagged in a more adult version of tag, we lost twenty percent of our net worth? That would change strategy.

We would be more risk verse. We might not be willing to venture as far from home base and that investment. Rule number two, stay close to home base. If our definition of is losing money, then home base is that target allocation that keeps us from suffers devastating losses. That target can change over time, and IT does change based on the current market environment, the markets temperature.

And we've discuss this in previous weeks when we can learn five percent on cash or earn two and half percent real plus inflation than that becomes our home base on the most risk averse investment, cash or tips is home base. When we can get an adequate return near home base, then we don't have to go take more risk where the risk of losing money is greater. One of the things with institutions and how they differ from individuals, these institutions are very focused on how do they perform relative to others, relative to a benchmark.

Because an institutional investor, a college and downtown in is typically there's investment committee members. And while they care about the institution, they also care about their reputation. Are they doing a good job? And that's measured by whether they outperformed the benchmark or they're doing as well as other university and damns. And so if the profit loses money, but i'll perform the benchmark well, that's okay. That isn't necessarily the case or individuals.

Individual investors in some ways are more like hedge funds because when hedge funds lose money, their fees get cut because they earn, in many cases, twenty percent of the profits as an incentive fee, and if a head friend loses too much of money, then many of their employees leave because they're not able to recoup those losses. Or IT will be some time to recall those losses, which means the fees will stay low. Hedge funds that lose too much money shut down.

And in some ways, a hetch fund can be ruined by large losses. And so more similar to individual investors, real tourist is to stay close to home base. However, you define that, our willingness to move away from home base depends on how things stand, which will talk about in the other rules.

Rule three is beware of dragon risk. Dragon risk was a term adopted by Cliff asness in Martin labels to very successful investors. IT refers to how many devil map makers used to draw dragons and other mythological creatures on the unexplored territories.

Other maps signifying unknown dangers that could reside there in investing dragon race represents all the unknown that can lead to large portfolio losses. Dragon risk is why we stay close to home base. The further we shift the portfolio from cash into more violates to investments such as stocks, the more exposed the portfolio is to unexpected events and negative surprises.

Another of the dragon risk hedge funds reduced dragon risk, in many cases by hedging, find the most cost effective way at any given point in time to protect the portfolio against large losses. They can do this by purchasing derivation securities, such as put options or other, in many cases, other derivatives that can be purchased in the private market. Well, many hedges wanted met this, but if you ask them what specific event they are hedging against, they often will say they don't know.

They're hedging against unpredictable and noble bad events. What not see nicless toller, we call black swans and will called dragons lying portfolio hedges is one way to protect against dragon risk, but in many cases, they can be very, very expensive for individual investors. Another way, though, is to stay close to homebase, choose an allocation based on our age that we will not be ruined if the stock market falls sixty percent and being willing to add and as a class or increase the allocation when conditions are more favorable.

When I mention favorite able, conditions are not talking about predicting a specific when we had you against drag on risk. We don't know what specific event could happen. The more specific the prediction, the more likely IT is to be wrong.

As predictions become more detailed, they can be skill based on our president opinion and biases. But the more specifically are when our returns are based on some binary event happening, cyp to currency goes up in Price. That's a very, very specific prediction to build a thriving portfolio.

We don't want our investment success to be dependent on specific predictions. We often hear from great investors such as Peter lunch, warm buffet, invest in what you know. But the reality is most investors, including most professional investors, don't know enough to run an entire portfolio investing what they know.

And I saw this as an institutional money manager as we would try to research long only stock managers or hedge funds that often times they got tripped up because something unexpected happen. They had a specific prediction and didn't happen dragon risk and they got hurt. So rule three is beware of dragon risk, the unknown and tried to structure diversified portfolio so that our success isn't dependent on specific predictions that we make.

Investment rule for is mind your investment seasons and IT focused on favorable investment conditions, which can be thought of as favorable weather. This is we don't launch a sailboat when heavy storms are likely. There are favorable investment conditions when the sun is shining and there is a tAilin that raises the likelihood of positive portfolio returns.

It's easier to identify favorable investment conditions. Then IT is to predict specific events. We know what the current yield on bond funds are or cash the estimate are expected to return.

We know that tips are most attractive now that you've been in many years. It's a favorable investment environment for treasury inflation protection security, something that will talk about more detail in and coming episode. I mentioned that the more specific the prediction, the more likely IT is to be wrong.

It's very, very difficult to predict whether it's going to snow this Christmas if you live in the north. But if you live in the north is easier predict that IT will probably be coller than IT was in the summer. And the reason being that when we're predicting it's going to be called in the winter, winter a season, not a one day event.

Winter is a time when due to the angled access of the earth, either the northern nor the southern hemisphere is tilted further away from the sun, receiving less eve its energy, hence its darker and colder in the winter. While some winter days are colder than others, it's safe, Better than the average winter. Temperatures will be colder than the summer, and so are closed and our activities will differ in the winter then in the summer.

And as an investors, how we go about investing will differ based on the investment season. And that's why rule number four is mind your investment season, understand where things are, what are valuations, where area of the market is more attractive? What area should we be avoiding? We did a plus episode last week on mortgage real state investment trust.

There's an investment guide on money for the rest of website on mortgage rats. IT is not a favorable time for mortgage rats right now, and that's why there have lost over twenty percent year to date. And so on money for the rest of us.

On money for the rest of us was plus we spend a great deal of time understanding what is the season for different asset classes. And we look at evaluations, we look at economic trends, we look at sentiment, the level of fear and greed in the market and natural number four, before we continue, let me pause and share some words on this week. sponsors.

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That comes last, David, to post your job for free. Terms and conditions apply. Rule number five is catch the popping corn.

As investors, we're human and we're irrational and we make decisions based on our emotions, our biases. We're inconsistent. We make cognitive air.

And one of those inconsistencies is we tend to extract late our recent experience far into the future. If a stock is appreciated and the portfolio companies doing well, we believe those trains will continue. In fact, our minds seek out information that confirms our belief while discounting items that contradict our current positioning.

Conversely, when an investment is doing poorly and losses are mounting, that this stasis palpable at we sell the memory of that lost stage of us for a very long time, that feeling is much stronger than how good we feel when things go well. We remember the bad things more. I remember negative reviews of my podcast more than I remember the positive ones, which is a shame, but that's why we're human.

And so when you think about those feelings and multiply those feelings and tendencies across millions of investors and thousands of investment securities, we can get asset classes, elements of the market, they get too cheap and others that get too expensive. The whole promise of value investing is investors overreact and investors can purchase a stock because they believe it's going to do Better than what everyone expects and because it's it's cheap. There's a margin of safety if things don't work out as they expect.

But investing in an individual security is incredibly difficult. I spent over sixteen years meeting with hundreds of investment firms. I call that a twenty one person research group as we try to find investors with the skill to make specific predictions about specific companies or security.

And it's incredibly difficult to do because the more specific the prediction, the more likely it's going to be wrong. And we have drag and risk negative surprises. And that leads to investment.

Rule number five, catched the pop in corn. One reason we invest in index funds in tf is we can catch the upside surprises. You think about how I popcorn proper works of hundreds of popcorn corneal spinning around the air popper's chAmber.

And within each corneal there's A A little water drop with that heat up. And when they get taught enough, the corner of corn pops as that the pressure builds. We know that if we make some popcorn, many or most of the kernel will pop, not all of them, but we don't have to predict which one.

We just know that the conditions are right for that. The same for investing in a diversified ed basket of underwater securities. If we in a, say, a value etf, we don't know which security is going to surprise to the upside. But the idea is that in buying something that's attractively Price, so equity reads right now realize investment trust are the most attractively Priced they've been since twenty eighteen. The divided yield is higher than average, the Price the funds from Operation is cheaper than average.

There are obviously risk with equity rats, but all things being equal, I would rather own equity reads now and add to my position like I I did a few weeks ago, not knowing exactly what's going to happen, but knowing conditions are more favorable able now than they were in twenty twenty one after equity reads had increased forty percent that year. And I reduced my allocation and we reduced IT in our model orta examples of money for the rest plus. And so the idea behind role number five is by baskets of securities index funder etf, so that we can capture the pop in corn.

The positive surprises the reality is with with the index fn etf, some will do Better than expected, some of the underline security will do worse, and they can to each other out, so that what drives performance is the underlying factor is the cash flow, the dividend yield, the growth of that cash low and what investors willing to pay for IT. So with equity reads, expect returns higher now because the dividend yields over four percent. And if earnings come in, if they are able to grow the rent learnings four percent, then that's eight percent return.

And then if the Price increases investors are willing to pay more than that is edited to that rule number six is watch for market swarms. A weather parameter helps in the short term weather forecasting, whether there's a change in atmosphere pressure. In the investment world, the equivalent is sentiment.

Sentiment measures the pulse of investors, their level of fear and greed. What is the predominant narrative? A story driving investment markets? We already know that investors are irrational.

They can become overly pessimistic or overly optimistic about the prospect of certain companies and that can lead to underwrite securities. Investors are always sharing with each other. And so there tends to be and can be group think as investors sort to work together. And we think about swarming birds, graco les or other blackbirds that swarm around where they act in unison. And the same can happen with investors.

And so when we're in a downward swarm, when we have economic, when valuations are very high, when we're not in a favorable investment season and then we want to stay closer to home base and not take as much risk when the atmosphere ic pressure drops, the parameter drops. There's some subjectivity as to the intensity, the duration or even the location of the storm. But just knowing a storm is coming at least can prepare for.

There's definitely some subjectivity when IT comes to investor sentiment. There's never a silver bullet saying like this is what's going to happen, which is why we can gradually adjust our risk based on investor sentiment. But we never go all in or all out of the market.

It's always a constant adaptation based on how things stand based on our live stage seven then is track the economic winds. Just a swimming bird seem to move as one. There are times when investors seem to act in unison, causing markets diplock, IT or sore. And one of those factors that can drive that is corporate profits and what investors are paying for those corporate profits.

At an individual company level there, there are a host of a micro factors that can influences earnings, such as the strength of a company's product line up, the quality of its leadership, what is competitors are doing at the index levels they mention these factors can cancel each other out and what drive total earnings for linux. Find it's what's going on with economy, what are overall corporate profits doing? As we mention, very difficult to predict the outcome for specific companies, but we can measure what's going on with the overall economy.

The overall economic pie is a growing, and what we're looking for is whether there is an comic headwind or tAilin. One of the tools i've mentioned numerous times on the show is leading economic indicators such as purchasing manager industry. And we've been in an environment where economic trends, as measured by purchasing manager indexes, es or business services done around the world asking business how businesses that's been more negatively biased over the past year.

And as a result, i've taken less risk in my portfolio, stayed closer to home base, and we've done the same in our motor portfolio based on rule number seven, which is, is to track the economic wind, at least understand what those leading economic indicators are saying, what is the season and we are in, and we tracked the economic wins, investment role. Number eight is followed, the traffic lights and the three lights that that I followed professionally, or the red, Green or yellow, red were more cautious. Green we go, yellow is more neutral. Market valuations.

What is market temperature for specific classes, classes? What is the economic wind analysis? What season is that? What are the economic trends? And the third is an investor sentiment.

What is the level of fear and greed? what? What are the narratives of stories driving investors? Are they acting more as a swarm in one way or the other? Or are there more desperate opinions? Now some variables are are very fast moving. Investor sentiment c can change very quickly. Others, such as the economic trends change more slowly.

And it's something that, that i've monitored in the several decades that i've managed assets my own and for others to help guide what to do where we today, not trying to make specific predictions, but be aware what the risk you are and what the opportunities are. And the investment road is, is to follow the traffic light, know our investment conditions, red, Green or yellow rose is diversify your baskets, baskets or assets. And this is straight for we've talked to about at numerous times, we diversify into cash, bonds, stocks and many other aso's pes, and we avoid concentration so that we can benefit from the underlying drivers.

And our success isn't based on specific predictions and investment on ten is don't burn nerves. In fifty nineteen, aranca z landed with a fleet of twelve ships near present day Better cruise mexico. The flutie had five hundred spaniard, three hundred natives, dozen horses in a few tenants.

Cortez wanted to conquer the asc empire. And the legend is that before launching the attack, cortez burned his ships to prevent his men from retreating through the ages. This brazen act has come to represent fully, committing to a course of action going on in burning all bridges.

But the legend is wrong. Cortez had nine of the twelve sail into the sand, grounding them. There's no word on in the other three ships.

But according to sue Thomas, in the book conquest, the burning ship air derives from sloppy handwriting. Two spanish words were confused in the written record, kam do, which means breaking, and commander, which means burning. And the thought is that cortez kept three of the ships unharmed.

Case, I didn't go well. He had a margin of safety, some protection. I used to meet anybody with seth Carmen of the bell post group.

His book is titled margin of safety. We don't burn our ships. We keep a reserve.

We buy insurance. We make choices so that we're not financially ruined. Those are tender of them. Then one, stop using institutional hometowns. Make sure the tools we use serve you as an individual investor to stay close to homebase. They do not make investment decisions that could ruin us.

We want to make an allocation decision more like a hedge fund where were not can be ruined if we suffer major losses. Will three is beware of dragon and risk the unknowns. What could ruin us will force to mind your investment seasons.

Be aware of where things are. What's the ongoing narrative? Do we have economic headwinds? Tailwinds five is catched the popping corn invest in asset classes that are cheaper.

They have more embedded surprises where our success isn't dependent on predicting which security will do the best. But we have a basket of security they help us with that sexes watch for market swarms. What's stop ongoing narrative is investment sentiment negative or positive.

Seven is track the economic winds. Leading economic indicators understand where we are from an economic standpoint because that's what drives corporate profit growth, which drives the return of the stock market. Ruai is follow the traffic lights, red, Green or yellow investment condition, something that we do monthly on money for the rest.

Rest plus will nine is diversify your baskets, many different types of asset classes so that we can benefit from the underlying portfolio drivers and get that diversification and rotas. Don't burn your ships. Make sure that we have some reserve savings insurance, perhaps the annuity for entering retirement are other ways so that if markets turn against us were not ruined, hopefully we have found these investing rules of them helpful.

That episode four fifty four, thanks for listening. I have loved teaching you about investing on this podcast for over nine years. Some topics though I just Better explained in writing or with a chart.

And that's why we have a weekly free email newsletter, the insiders guide in that newsletter. I share charts, grasp and other materials that can help you Better understand investing. It's some of the most important writing I do each week.

I spent a couple hours on that newsletter on wednesday morning as I try to share something that will be helpful to you. If you're not on the list, please subscribe go to money for the rest of us dot com to subscribe to the free insiders guide weekly email newsletter. Everything I ve shared with you in this episcopate for general education have not considered your specific risk situation, have not provided investment advice, this is simply general education on money investigating the economy. Have a great week.