Ten Simple Money Rules for Investing Success
Bad decisions and poor behavior are the primary reasons why many fail to meet their financial goals.
Bloomberg, July 5, 2021
To hear an audio spoken word version of this post, click here.
Creating lists1 is a useful way to organize your thoughts: I have created lists of rules for Investing, Valuation, Stock tips, Goldbuggery, even useless financial phrases to avoid. I find these exercises to be valuable ways to figure out what I think.
Thinking about money – saving it, spending it, and most of all, how to invest it – is something I have spent decades doing. This has led to recognizing several fundamental truths about capital.
Naturally, I have organized these rules into a list:
My Top 10 Rules for Money
1. Investing Is Both Simple and Hard: The basic premise behind successful investing is easily understood: “Invest for the long term, be diversified, watch your costs, and let compounding work its magic.”
But following through can be challenging. Humans are plagued by an inability to just “sit there and do nothing.” Failing to do nothing leads to costly errors and loss of capital that erode returns. Understanding what is required is very different than being able to perform, regardless of circumstances, for decades on end.
This leads us to:
2. Behavior Is Everything: The inability to manage emotions and behavior is the financial undoing of many. To paraphrase William Bernstein, “the extent you succeed in finance is based on your ability to suppress your limbic system. If you can’t do that, you’re going to die poor.”
Even the greatest stock pickers will underperform if unable to control their emotional impulses. Allowing those emotional hot buttons to get pressed is how people go wrong in investing. There are no shortcuts, secrets or get rich quick schemes that work, except for my 3-day workshop where I reveal the secrets of the ultra-rich for the low, low price of $4,995. Sign up here.
3. Moderation In All Things: Think of the majority of the assets in your portfolio -– hopefully a diversified, global mix of passive index funds — as the basic meat and potatoes of investing. You can add seasonings, herbs, and vegetables to spice it up and add some flavor.
Want to do some early-stage investing in tech start-ups? Maybe some real estate speculation? Perhaps a few private equity investments in non-public businesses? Maybe even a fun trading account?
I don’t have a problem with any of that as long as it meets two conditions. First, you should understand that the odds of success are against you. Many billions of dollars are aggressively competing in the same space for returns. The professionals are always searching for an edge, and even with one, there are no guarantees of success.
Second, it should be a smallish chunk of your liquid net worth, perhaps about 5% to 10%. That is enough to provide you a little fun and intellectual stimulation. Some might even discover a knack for such investing. But the amounts should be small enough that if the investment doesn’t work out it won’t affect your financial plan.
4. Risk and Reward Are Inseparable: Risk is best defined as the probability of your returns differing from your expected outcomes.2 The problem is that many investors want better-than-market returns while assuming minimal risk. But returns are a function of the risks assumed.
Risk-free U.S. Treasuries yield almost nothing. To do better, own equities. But that adds volatility to your portfolio. If you seek higher returns, you can add low beta stocks that have the potential to do better – or worse – than the market as a whole.
5. Spend Less Than You Earn: Budgeting is simple: Income goes on this side of your household balance sheet, expenditures on that side and make sure the latter is lower than the former. It’s that easy!
I have zero tolerance for the spending scolds who tell you never buy a boat, don’t get a new car (especially a sports car), and avoid buying lattes. This is lazy, ignorant and poor advice given by charlatans and frauds who do not understand math or finance. If they did, they would add the magic phrase: “…if you cannot afford it.”
But if you can, then spend your money however you like but preferably thoughtfully. People often skip purchases they can afford out of misplaced guilt.3
6. Leverage Kills: Using borrowed money for nearly anything is the negative manifestation of the three prior rules. Yes, get a mortgage to buy a house you can afford. But never use borrowed money to buy speculative assets that are subject to further capital calls.4
7. Understand Your Role: The markets are populated by all kinds. There are traders and investors, hedgers and speculators, and everyone has different risk tolerances, time horizons and financial goals. Do not assume what any of America’s 800 billionaires have to say about investing is especially relevant for your needs. Their goals are likely different than yours.
8. Be Aware of Your Limitations: What gets so many investors into trouble “is not what we don’t know, it’s what we know for sure that just ain’t so.”5 Understanding the limitations of your cognitive errors and belief systems is just the start. It’s also important to know what inadequacies you have financially, emotionally and behaviorally. Operating outside of your own capabilities is a good way to run into trouble.6
9. Own It: You are responsible for own financial well-being, not the Federal Reserve, the government or whichever huckster is yelling the loudest on TV at the moment. You alone accept responsibility for your investments and spending. The sooner you take ownership of your financial circumstances, the better off you will be.
10. Invest In Yourself: This is the most important investment you can make. Educate yourself, develop an expertise and add to your professional skill stack.7
And invest in your future by making sure you fully fund your retirement accounts every year. Make those long-term investment needs before spending on short term wants (that’s as much of a scold as I can muster).
After making my list, I asked Twitter folks for their favorites. The result was hundreds of suggestions. Consider them an ala carte menu showing both breadth and depth.
My final admonition is the most important rule: “Behave!” As noted throughout, ill-advised decision-making and poor behavior are the biggest reasons why many fail to meet their financial goals. All of the above either directly or indirectly refers to behavioral issues dressed up in the lexicon of finance.
Go make a list of rules, then follow it. Your future self will thank you.
Your Favorite Money Rules (July 2, 2021)
Ritholtz’s Rules of Investing (part I) (October 6, 2012)
Ritholtz’s rules of investing (part II) (October 20, 2012)
1. Lists are a useful way to organize your thoughts: The Top 10 list was the heart of David Letterman’s late night career; the listicle has been a big driver of social media and online content creation. As a heuristic, the list is a useful mental shortcut (although that does come with some baggage).
2. Note this is different than “Uncertainty.”
3. In my office, I have seen vacation homes, sailboats, and the occasional Ferrari purchased only after many assurances that “Yes, you can afford that” (you can afford 100 of them, but let’s start with 1).
4. Archegos Capital Management was running about 5 to 1 leverage, then blew up quite spectacularly, losing $20 billion and wiping out founder Bill Hwang. Lehman Brothers, founded in 1847, regularly ran 20 to 40-to-1. They shuffled off this mortal coil in 2008 during the financial crisis, an act more akin to suicide than murder. The most extreme example was Long Term Capital Management, which ran 100-to-1 leverage. When they blew up they nearly took the banking system with them.
5. For example, that above quote, often ascribed to Mark Twain, is more likely unknown.
6. The lesson taught in high-performance driving schools is the importance of operating within the capabilities of both the vehicle and the driver.
7. Take care of your physical body (eating healthy, exercising, getting enough sleep), and your emotional state (meditating, relaxing).
I originally published this at Bloomberg, July 5, 2021. All of my Bloomberg columns can be found here and here.