You may have heard billionaire Warren Buffett’s investment rules before. Rule #1: Never lose money. Rule #2: Never forget Rule #1. Buffett’s strategy sure has worked for him over time, although in truth there are no guarantees that you can avoid losing money in risky investments such as stocks. Even Buffett has made some mistakes. We admit to not being as smart as Buffett, so when we establish our own investment rules, we want to start with something that seems obvious, but is routinely ignored. MODUS ADVISORS RULE # 1: DON’T DO ANYTHING DUMB! I know what you’re thinking, “Of course. Who would do things that they know are dumb?” The unfortunate answer is that many investors, amateur and professional, make dumb mistakes. The problem is that they usually don’t think about it until after something goes wrong. At Modus Advisors, we don’t like nasty surprises, so we spend time up front thinking about what can go wrong with any investment or strategy. It doesn’t ensure that nothing bad can happen, but it creates a rational framework for future decision-making. Here are a few examples of the dumb things you shouldn’t do and why it can become a problem. 1. Don’t try to time the markets! Many investors try this every day and the appeal is clear. If only you could always be invested in something that’s going up and stay out of things that are going down, you could be fabulously rich in a relatively short period of time. But hoping for it and accomplishing it are two different matters. Good luck finding anyone who has actually succeeded in timing the markets over many years. The only certainty you have by trying this is that you’ll put a lot of time into it, pay more in transaction fees, possibly pay more in taxes (assuming you make any money, of course), and most likely raise your stress level. A few lucky ones will end up making more money, but most will fail. As an alternative, you are likely to earn profits over time even if you are just a passive participant in the stock and bond markets due to economic growth throughout the years. 2. Don’t believe that you know something that the market doesn’t know! This is a common problem for amateur investors. Comments such as, “I should buy this stock because the company is growing really fast” is a typical example. The problem is that every other investor following that company knows that the company is growing fast, too. And they’ve already factored it into the price that they’re willing to pay for the stock. So just knowing things about a company gives you no advantage in a competitive financial market. You either need to know something that other investors don’t know (excluding insider information, which is illegal to trade on) or you need to see that other investors are misinterpreting the available facts. Better analysis may lead to better performance, but realize that you are trying to outsmart millions of other investors and analysts that have their money or their jobs on the line and thus are highly motivated to understand everything you do and more.
Every day we read about bad news for the economy, but stocks keep going up. Does this make sense?
If you follow the financial media, you will regularly hear comments such as, “I’m cautiously optimistic on stocks here”. What this particular prognosticator is doing is trying to hedge his bet so that he will be able to claim success on the prediction later on, no matter what the outcome. If stocks do well, he’ll proclaim, “I told you to be bullish!” On the other hand, if stocks do poorly, he’ll say, “My caution has been warranted”. It’s all just public relations spin and everyone plays along, but it doesn’t help investors make good decisions if no one accepts accountability for their recommendations. Modus Advisors doesn’t play these games. Our goal is to serve our clients as well as we can, not to generate hype in the media. But we do believe in caution. And we believe in optimism. The difference between Modus Advisors and most financial commentators is that we accept both of these things as permanent conditions for any investment strategy. Why be cautious? During the past few months, we’ve seen social unrest close to home with the hot button topic of union rights in Wisconsin and other states. We’ve seen violent uprisings in various Middle East countries that toppled governments and sent oil prices sharply higher. We’ve seen a massive earthquake and devastating tsunami hit Japan. We exercise caution because there is always risk, much of it unforeseen and even in cases where something is predictable, the timing is usually highly uncertain. Why be optimistic? Quite frankly, for all of the problems we face today, the U.S. and the rest of the world has been through worse, but the global economy continued to grow over time and investors have generally fared well as long as they were committed to a long-term strategy. Substantial dislocations such as two World Wars, a huge number of smaller wars and conflicts, the Great Depression, dozens of recessions, inflationary bouts, financial crises, etc…none of these have stopped the trend towards increasing prosperity in the world.