Look Back To Move Forward Successfully
By Norton Reamer and Jesse Downing
Thinking about how to improve your portfolio next year? Don’t forget the last five thousand.
A healthy understanding of investment history is a true bonus for investors, lay and professional alike, to avoid pitfalls and to be the best advocates for their own financial interests. Ancient history has lessons for all portfolios today, from personal retirement accounts to university endowments.
For thousands of years, the only people who qualified as “investors” were wealthy and politically connected landowners. Yet in the blink of an eye, historically speaking, that world has been replaced by one full of investment opportunities for average people: stocks and bonds, mutual funds, life insurance, pensions and real estate.
Successful investors throughout history have stuck to a few basic principles. As complex as investing can be, it is possible to avoid some obvious mistakes.
Here are four guideposts that can help investors as they head into 2016:
- Focus on what’s “real” – Don’t get distracted by the form of an investment (e.g., a stock certificate or a bond note). Make sure you understand the real asset behind the piece of paper, such as the company behind the stock you are buying, or the public works project issuing the bond. When buying a mutual fund or other packaged investment the same rule applies: make sure you understand the fund manager’s criteria for buying and selling securities in the portfolio. Focusing on what’s “real” should always be the priority.
- Focus on fundamental “value” – In its simplest form, the value of an investment today is determined by the present value of its future cash generation – that is, the cash that the investment will produce over its lifetime. Don’t be distracted by market gyrations. Take a long-term perspective and understand that markets go up and down, often for reasons other than fundamental value. Investors often forget this basic rule and allow emotion to guide their decisions and make mistakes as a result.
- Consider the intelligent use of leverage – Excessive leverage is dangerous, but most of the great fortunes in history were built using moderate and smart amounts of leverage. For example, a home mortgage is a sensible form of leverage for most families. On the other hand, taking out a second mortgage to fund a speculative investment is probably foolhardy.
- Allocate your capital – Every investment is an “allocation” of capital. That is, it’s a choice between competing priorities and opportunities. Make informed, deliberate choices and tradeoffs as you decide where to put your money, especially when the choice is between saving, spending, and investing. Think through your needs. Do your best to be accountable to yourself. Set some objectives and stick to them.
Investment is a fundamental human activity, and in the modern world it’s open to more people than ever before. We encourage everyone to learn some basic investment principles and take full advantage of this unprecedented opportunity.