The Model Portfolios ProgramJune 15, 2022
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The Twelve Universal Laws of Successful Investing
by John R. Stewart, Senior Financial Advisor/Portfolio Manager | June 15, 2022
More and more Americans like you are actively saving for their future. But how and where should you invest your money to make sure it provides you with the dollars you’ll need?
If you drop a rock from your hand, it will fall; if water gets cold enough, it will freeze. These are laws of nature. There are also Twelve Universal Laws of Successful Investing. These laws were developed to assist individuals to set and then achieve their financial goals and objectives. The sooner you develop these habits, the sooner you too can be on the path to creating wealth. As Will Rogers said, “Even if you’re on the right track, you’ll get run over if you just sit there.”
Unfortunately, many people spend more time planning their annual vacation than they do planning for their future. Hopefully, after reading The Twelve Universal Laws, it will motivate you to start now to plan and provide for your future.
- THE LAW OF SETTING OBJECTIVES
No two people are alike. Some are dependable. Others are more unpredictable, yet offer flashes of brilliance. Investments are the same way, ranging from low-risk money market funds to high-risk speculative stocks.What type of investor are you? What is the primary objective of your overall investment program? Is it for purchasing a home, college funding for your children, retirement or building an estate? The answers to these questions can help you set your objectives, but you also need to identify your Investment Profile to understand your financial ability to handle risk.If you have little financial ability, you probably spend more than a third of your household income paying debts like credit cards, car payments, rent or house payments, and have no savings you can use in case of a major emergency. It’s also possible that you could lose your job or retire in the next year; or that you will be spending a lot of money in the next year on your children’s college education.
If you have medium financial ability, between 10% and 33% of your household income goes to paying debts. In case of an emergency, you’ve saved enough money to pay 2 to 4 months of living expenses; it’s not very likely that you’ll lose or change your job in the next year.
If you have high financial ability, you spend less that 10% of your household income paying debts. In case of an emergency, you’ve saved enough to cover at least 5 months of living expenses; it’s not very likely that you or anyone else in your household will lose their job in the next year.
After determining your financial ability risk, you next need to determine your willingness to take financial risks. What is your comfort level with different types of investments? What is your attitude toward a drop in the value of your investments?
You are a conservative investor if you will quickly change to another investment if the value drops. You prefer putting your money in a guaranteed account—one where your money is absolutely safe—even if this means you will earn a lower interest rate. Your current investments are CD’s, money market funds and/or Treasury bills and notes. They don’t pay a lot of interest, but you know your money is safe and secure.
You are a moderate investor if you will change to another investment if the value drops 15% or more. You think it makes sense to put some of your money in more risky investments because you have to keep up with inflation; your current investments are stocks from big corporations, mutual funds that are pretty reliable and/or high quality corporate bonds.
You are an aggressive investor if it doesn’t bother you if the investment you own drops in value. This might even be a good time to increase your investments since prices are low. You are willing to put most of your money in investments that have the potential to pay big returns, because you want the chance to beat inflation. Your current investments are in the stock market. Even though you could lose money, you prefer to invest in smaller, newer companies because they pay off handsomely if they succeed.
After you determine if you have the ability to invest and the type of investor you are; you’re on your way to setting your objectives by selecting your personalized Investment Portfolio.
There are three broad investment objectives that successful investors consider. These objectives are:
c. Total Return
These objectives are used in structuring a broad cash/equity/fixed asset mix (asset allocation) within the portfolio.
The next step in establishing the asset allocation and the guidelines for the overall portfolio is to determine which of these objectives best fits your individual circumstances. By putting this into writing, you are establishing your own Investment Policy Statement. In writing your Investment Policy Statement you will understand your own goals and constraints (fiscal and psychological) for creating your investment portfolio.
- THE LAW OF RISK VS. REWARD
Successful investors know the old risk vs. reward tradeoff. “The greater the potential reward offered by an investment, the riskier the investment may be.” There is some risk associated with any investment. Still, prudent investors can measure risk with some degree of accuracy. By being content with modest, but acceptable returns, they only need to live with modest, but acceptable risks. This is the investment program, which most investors should have and the style, which, over time, helps you achieve your financial goals. Wall Street is littered with some of the most successful speculators of all time; those who made a fortune, but died broke. Speculating is gambling and gamblers usually play until they lose.In a nutshell, you can summarize all the wisdom from the ages about investing into a few words… “There is no such thing as a free lunch.” The potential for growth is always accompanied by the possibility of decline. You can achieve most of the characteristics that minimize risk, but you can’t have everything.If you want guaranteed current income from an investment, you can get it if you’re willing to sacrifice the chance of its appreciating in value. If you hope for appreciation, you’ll have to give up some safety. If you insist on safety, you’ll have to give up some income and growth potential. Every benefit has a price. And this quest will lead you directly to the most basic investment tradeoffs—the greater the potential cash flow or appreciation from an investment, the greater the risk that it will not be delivered. You can put your money in a savings account and earn less than 4% guaranteed. Or you can pick a promising growth stock and make 50% a year or more if the stock moves up, or lose 50% a year if it moves down. Or you can put your money on Sea Biscuit in the ninth race and make 1,000% on your money in the few minutes it takes to run the horse race—or you can lose it all, which is far more likely. There are no free lunches.
- THE LAW OF DIVERSIFICATION
Everyone has heard the saying, “Don’t put all your eggs in one basket.” However, it could also be said that if you had the right basket you could keep all your eggs in just one and do quite well. Clearly, anyone who bought nothing more than McDonald’s, Wal-Mart, Apple or Limited Stores when these companies just started (to name just a few) is a very happy investor.Diversification can be accomplished by purchasing the entire Standard & Poors 500 or by constructing a portfolio that replicates that index. To accomplish this you need to divide the market into the eleven Economic Sectors and invest proportionately in each sector depending on the systematic factors that affect the market. These factors might include: interest rates, the value of the dollar, the increase or decrease in the Gross Domestic Product, the current position of the economic cycle, the price of energy, etc. Each factor affects individual stocks differently, and these factors can change continuously.There are 84 industries in the S&P 500. However, only five industries represent 27% of the total market capitalization of the S&P 500. Randomly selected, stocks in the same industries can concentrate risk rather than diversify it.
It is doubtful whether an equity portfolio can be even minimally diversified with fewer than eight securities. At the other end of the spectrum, a portfolio with 35 selected securities could produce a diversification equal to 98% of the S&P 500. Studies have shown that a portfolio of 16 selected securities can produce a diversification equal to 85% of the S&P 500.
Keep in mind that the Law of Diversification accomplishes two things: 1) It can help protect you from any loss that may occur if one investment should perform poorly, by reducing risk, and 2) it reduces the potential for outperforming the market.
- THE LAW OF CONCENTRATION
Many in the investment community seem infatuated with diversification. Is it overemphasized? Perhaps as many bad investment decisions have been made in the name of diversification as for any other reason. Over-diversification can lead to mediocre investment results and can make proper portfolio supervision a Herculean task.Concentration is the other side of the diversification coin. This approach focuses upon a small number of carefully selected securities that have to be closely followed. One who puts “all his eggs in one basket” must be prepared to surrender diversification’s supreme attribute—reduction of risk.However, not all forms of concentration embody undue risk. The investor seeking maximum safety of principal over a relatively short time horizon could place all of his money into a single Treasury bill. This kind of concentration would provide no portfolio risk. On the other hand, the investor looking for a high return and a “quick kill” could put all his capital in one speculative stock. This investor assumes extraordinary risk and the possibility of substantial loss if the investment is not successful. However, the reward potential is presumably equally large; for some investors, such a tradeoff is acceptable.
It is therefore the balance between the Law of Concentration and the Law of Diversification that presents the greatest challenge to successful investing.
- THE LAW OF ESTABLISHING A STOP-LOSS DISCIPLINE
Most successful investors do the opposite of most other people. They are not afraid to sell when a stock or bond drops in price. They admit that they made a mistake for one reason or another and readily go on to another investment. Many investors want to “hang on” to the stocks that are below their purchase price and sell when it is back to a break-even situation. They hesitate to turn a “paper loss” into a “real loss”.In a typical portfolio, usually a third of the stocks go up, a third stay even and third go down. With those stocks that go down, it is a good idea to set a stop-loss point—typically 15% below the current price that the stock will be sold. This does two things: 1) it keeps a small loss from becoming a large loss and 2) raises cash, which can be redeployed into another more profitable situation or put on the sideline until the dust settles.
- THE LAW OF PATIENCE
Major stock market moves occur over relatively short periods of time. Therefore, most of the time, your investment in stocks (equities) is treading water. One of the best decades for stock investments was during the 1980’s. The market represented by the S&P 500 (a broader-based measure of the market than the 30 stocks comprising the Dow-Jones Industrial Average) posted an incredible 17.5% annual return. During that decade the market was open a total of 2,528 trading sessions. Had you missed just 40 of the best days during that decade, your annualized rate of return would have dropped to just 3.9%-and you could have done better buying CDs.A more recent case in point– 1991, when the S&P 500 was up over 26% for the year. However, the increase for the most part occurred over 21 days, from January 16th through February 13th (up 17.6%) and the final 7 days of December (up 10.3%). The market was open 253 days in 1991, and the other 225 days (89% of all trading days) produced a 1.5% return!A history of the capital markets clearly shows that investing in equities provides a much higher rate of return than other investments—but you have to have patience.
- THE LAW OF LETTING THE WINNERS RUN
Most people have no trouble in buying stocks. Where they run into trouble is in determining when it’s the right time to sell. Most successful investors let the stocks in their portfolio that are doing well have time to “run” and go even higher. They will add more money to those stocks as they are on the way up. They rarely buy more if the stock is doing poorly. By setting a trailing 5 to 15% stop below current price, it allows those stocks that are doing well to reach their maximum potential—although you won’t sell at the absolute top—it still allows you to lock in a majority of the profit.
- THE LAW OF COMPOUNDING OF MONEY
Albert Einstein replied when asked “what was the greatest invention made by mankind”, “The compounding Effect of Money”. Most everyone has heard of the “Rule of 72” which means that if you divide the factor number 72 by the stated interest rate, the quotient is how long it will take for your money to double. An interest rate of 7.2% would take 10 years for the money to double. The greater the rate of return, the quicker your money doubles.It has been said that everyone could become a millionaire if they lived long enough. The most important factor in any investment program is the amount of time before you’ll need your money. Your time frame is called your Time Horizon, and the longer you have to let your money grow, the better your chances of meeting future goals.With a lengthy Time Horizon, your investment can have more opportunity to earn a higher rate of return and beat inflation. As an example, consider Sally and her brother John. Sally started right out of college and invested $2,000 per year into an IRA account. She did this continuously from the time she was 21 until she was 31. At this point, after having invested just $22,000, she quit her job to raise a family and made no further contributions. Her brother John, on the other hand, started saving $2,000 a year when he reached the age of 31 and he contributed this amount every year until he reached the age of 65. His contribution totaled $70,000 more than three times what Sally invested. Assuming that both accounts average just 8% per year, when Sally starts to draw on her retirement nest egg, she has a total of $531,596. Her brother has just $372,204.
Not only does money grow faster the earlier it is invested, the odds of your being a successful investor, particularly in the stock market, goes up the longer you have your funds invested. For example, based on the action of the market for the past 80 years, if you invested for just one year, you had a 62% chance to have your account grow. This means that 38% of the time, you could have lost money in the stock market.
However, stocks have increased in value during 89% of the rolling five-year periods dating back to 1926, 97% of the 10-year periods and 100% of the 15-year periods over the past 80 years. By contrast, investing for the short-term can produce extremely volatile results, whether in stocks or long-term U.S. Government or corporate bonds.
Of course, stocks (equities) have a greater degree of risk of price fluctuation than short-to-intermediate term U. S. Government securities such as Treasury bonds and bills, which offer a government guarantee as to the repayment of principal and interest if held to maturity. The past is no indication of future returns for stock market investments. There is no guarantee that stocks will continue to produce a remarkable long-term record despite the Depression of the late 1920’s and early 1930’s, several wars, numerous recessions and fundamental changes in the economy.
- THE LAW OF PRUDENT INVESTING
Success in money management is not a windfall that comes to some and not to others because of fate, luck or chance. Success in money management is easier if you have a plan and if you follow that plan. The Law of Prudent Investing realizes the risk/reward relationship and takes advantage of compound interest. In 1748, Benjamin Franklin, who was a big fan of compound interest, described it this way: “Money is of a prolific generating nature. Money can beget money and its offspring can beget more”. We must realize that people are living longer than ever before. And it’s much more important to make wise decisions when it comes to investing, because that money will have to last for a much longer period of time.Here is the good news/bad news. The good news is that today’s retirees are living longer, healthier lives. The bad news is that today’s retirees are living longer, healthier lives. And it’s easy to see the problem; not only are people living longer, they are retiring earlier. As a result, many people will spend as much time retired as they did working. When that happens, it is possible that you could outlive your money. In 2000, the average life expectancy was 78.8 years. Consider that today there are 63,000 Americans aged 100 or older. By the year 2030, that number will grow to 360,000. Consider that today, the fastest growing segment of our population are those over age 85. The health care cost of those Americans aged 65 or older currently account for over 37% of our entire health care costs.Having peaked at over 9% back in the 1960’s, today’s national savings rate of minus 2% comes at precisely the wrong time. Even a quick glance at the numbers above should indicate that if you want to provide for a meaningful retirement, you’d better be taking steps now—not later. There has never been a more important time to make wise, prudent decisions regarding your investments, insurance and estate planning needs.
Even if inflation averages just 4% per year, today’s retirees will need twice as much income 20 years from now to meet the same expenses. A modest inflation rate quickly shrinks the buying power of your income. To protect against loss, you need to factor inflation’s impact into your savings plan.
- THE LAW OF PURCHASING POWER; THE RAVAGES OF INFLATION
Just as a successful sailor learns to use whatever wind there is, the successful investor knows how to use inflation. They use it to propel their portfolios by tailoring their investments to the times. Inflation is a fact of life. It has been your constant companion since the day you were born. From all indications, it will be with you for the remainder of your life. The wealthy learn to accept inflation. They learn how it works and how to harness its energy.What if I were to say to you that I want to present an investment idea for your serious consideration? I know that its record has not been very good, but I have faith that it will improve. It was worth $100 in 1957, by 1961 it had dropped to $96, and by 1981 it was worth $30. Today it is valued at $18—but don’t let that discourage you from investing in it! Now, before you fall off your chair and say, “You must be kidding!”—I want you to consider that what I’ve just described is what is being recommended by most of our state and national banks, by all of our savings and loan institutions, and by the Federal Government itself. What is this investment? It is the U.S. Dollar!This example clearly illustrates what has happened to the purchasing power of the U.S. Dollar over the past few decades. Many people today have money earning historically low interest rates such as CDs and money market funds. Those investments have been viewed by most investors as “safe” investments. But when you focus on the real world rate of return, we see a much different picture. When you factor in taxes and inflation, many are losing ground in an investment they thought was safe. So here’s the question to think about: “How safe can any investment be, if it has lost you the only real value your money ever had—it’s purchasing power.
- THE LAW OF FRUGALITY
Abraham Lincoln said, “Prosperity is the fruit of labor. It begins with saving money.” Successful investors consider this maxim to be the cornerstone of their wealth-building efforts. Oscar Wilde defined a cynic as “a person who knows the price of everything and the value of nothing”. Following the Law of Frugality allows you to focus on the value of each dollar invested, not on the price. Most investors isolate on the price of a particular investment and almost always lose. Successful investors focus on the value of an investment and usually win. If you are to begin an investment program, it is absolutely crucial that you do it soon, not just because of the dangers of procrastination, but also because of the inescapable logic of mathematics. We’ve already looked at the wonders of compound interest, but we should look again. With compound interest, a sum does not increase arithmetically, it increases geometrically. That means that money does not grow at the same rate forever. The longer it’s held, the faster it grows. Eventually, it grows at a truly dizzying pace.Consider for example, the sum of $10,000 invested at age 35 and held until 65 at 10% compound interest. That $10,000 grows to over $174,000. If that same $10,000 were invested at age 25, however, it would grow by age 65 to over $452,000. Thus a single dollar not invested at age 25 represents $45 you’ll not have when you turn 65.The investments you make when you’re young will be the most effective one’s you’ll ever make. The property of compound interest also points up to the real tragedy of chasing after elusive get-rich-quick schemes. You see, it’s bad enough to lose the money that you invest in those schemes, but its even worse to lose the years of relentless compounding that money could be enjoying if it had been invested prudently—and frugally.
- THE LAW OF GOAL SETTING
Most people today can have it all, but the problem is, most investors today don’t know what “it” is. Once you define what “it” is, then you can set realistic goals and plan your strategy. Ultimately, it can be very rewarding. There’s nothing magical about the process of acquiring wealth, and it does not require great luck or skill. It does, however, require planning and discipline. And it does require that you give up any notion that you can get rich quick, but you can build your wealth slowly. You see, financial planning is directed at the future. A financial plan is a blueprint that evaluates your current assets and liabilities, identifies, the things you want or need to provide for, and lays out a strategy to pay for them. Developing the plan is one thing, sticking to it is quite another. A successful financial plan can help you beat inflation, minimize taxes, (both income and estate), manage the unexpected, provide money for special expenses, and enrich your retirement.In addition to your investment goals, you should have plans in place to cover your life insurance and disability needs, long-term care, and your estate planning needs. Your life insurance is a key part of financial planning and prudent goal setting. Insurance can fill the gap left by your death or disability.Disability income insurance is a mostly over-looked, yet much needed coverage that pays you a monthly income if you’re unable to work because of injury or illness. Statistics show that disability is far more probable than death, especially if you’re young or middle-aged. At age 42 you’re about 4 time more likely to be disabled for at least three months before retirement than you are to die.
And finally, the law of goal setting can’t be complete without a discussion of estate planning. If you’ve accumulated substantial wealth, it makes sense to have a comprehensive plan involving gifts, trusts, and other strategies. The more you’ve accumulated, the more estate planning can preserve for your heirs, sometimes to the tune of several hundred thousand or even millions of dollars.
In conclusion, the best time to get started is now. The financial markets fluctuate every day and you may miss out on opportunities while trying to avoid volatility. Remember that while market timing may be critical in short-term investing, most planning is a long- term process, requiring time—not timing.
This article represents the opinion of John R. Stewart as of June 15, 2022. John R. Stewart is an investment advisor representative with Physicians Wealth Solutions, LLC, a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risks and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discusses herein.