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Rules of Investing Thumbnail

Rules of Investing


The rules of investing are similar to the rules of physical health.  The information is widely known and not overly complicated.  For physical health – 1) eat a balanced, healthy diet 2) exercise 3) get sleep.  Yet, America and to a lesser extent the world is getting fatter and less healthy.  The same concepts apply to investing – 1) Own a balanced portfolio 2) diversify 3) re-balance 4) hold strategy.  None of these are revolutionary ideas and yet most of America doesn’t do this.  These are some of my rules for portfolio creation.


1. Own a balanced portfolio.

Similar to the food analogy balanced is tricky.  In diet, balanced doesn’t mean equal amounts of everything.  Same with investing, it does not mean own equal amounts of everything.   The concept of asset allocation has been around a long time and it is one of the most over used investing axioms.   So the question becomes – What is a balanced portfolio?

The answer is it depends.   Not everyone should be invested the same way.  The keys here are making sure that you have a portfolio with an appropriate amount of risk for you.  Okay – what is risk?  The best measure of risk is the volatility or variability in the return of an asset.  


Now, I have NEVER had a client complain about volatility on the upside.  People only complain about volatility when the market experiences negative volatility.  The best measure of volatility is standard deviation – what is the magnitude of a bad/negative outcome.  It’s key to understand the likelihood of bad outcomes and how bad the possible outcome is.   Typically, I’ll use 3rd standard deviation – the likelihood of a portfolio underperforming this is small ~.25%.  Figure out what you’re uncomfortable losing in a given year and build a portfolio around this concept.


2. Diversify

This is the equivalent to exercising  When we exercise should we do the same thing over and over again?  No, we can’t only lift weights with our legs and never with our upper body.  You can’t only lift weights or only do cardio.  There must be a diversified work out regime.  The same holds true for investments.

There are LOTS of institutional investors now, there are LOTS of ridiculously smart people who work in investing.  Our goal isn’t to outsmart, outguess or time the market.  It is to harness the power of the market and make the returns repeatable over long time periods (15+ years).  When we don’t have long time horizons, we need to take measures to reduce risk.  So what is diversification?  When am I diversified?

Let’s start with what it isn’t.  It isn’t owning 25 stocks, it isn’t owning 5 or even 10 mutual funds.  Please, please, please look at home many holdings your mutual funds have.  Please look at the top holdings and the overlap between your funds.  The goal of diversification is to spread risk out over a number of investments.  To this end, it’s also important to look at the concentration of holdings.  Ideally, we don’t want more than 2% in any one concentrated position and no more than 15% in your top 25 holdings.

Diversification comes from broad investing.  This means 5,000+ unique holdings and ideally 10,000+.  We want to exclude fixed income (bonds) from this count.  We want to have diversification across different asset classes because they react to changes in market conditions differently.  What are asset classes?  Stocks, bonds, real estate, cash, to name a few.  Other differences are the size, location and relative value of stocks.  Size – Large 10 billion+ in total value, mid sized 2B-10B in total value and small less than 2B of total value.  Location – in the US, in Europe, in Asia, in developed countries, in emerging markets.   Relative Value = growth vs value.   Growth stocks have a high value compared to their earnings.  There is the expectation of growth of earnings.  Value stocks have a low cost for dollar of earnings.

Diversification is a defensive tool.  It is used to help level out the highs and lows of market swings.


3. Re-balance.   

The goal is to own the initial portfolio – that’s why you created it.  This is the equivalent of sleeping.  You need to rest and recharge.  When we rebalance an investment portfolio, it is similar to recharging it – reverting back to it’s initial state.  We don’t want to get out of balance.

Over time, some investments will do better than others – this is normal, natural and almost unavoidable (we don’t want to avoid it either).  However, when we do have some investments perform better than others, we become unbalanced.  If our aggressive investments to better, then as the market rises, we take on more risk.   If our conservative investments to better, then as markets fall, we take on less risk.  Periodically rebalancing will get us back to our original allocation.   

Rebalancing can force us to sell high and buy low.  Is it possible perhaps even probable that our winners will continue to win?  Yes, until they don’t.  I don’t want to add more risk when markets go up.  I don’t want to take less risk when markets go down.  

Rebalancing is another defensive tool.  It is used to hold to an appropriate amount of risk – yours.

4. Hold Strategy

Holding strategy is the hardest rule to follow.  The health equivalent is a personal trainer.  Do we all know that we need to eat healthy?  Eat a balanced diet? Exercise more?  Sleep more?  YES, of course we do.  So why don’t we do it?  It isn’t lack of knowledge or lack of motivation.  It’s lack of accountability and follow through.  This is why personal trainers exist.  Sure they help us with specific knowledge that give us a better method for eating healthy, balanced diets and having a good work out routine that covers all of the areas that you want to improve.  However the real benefit to working with a  trainer is the accountability.

It is widely known that not selling when a sudden drop occurs and yet every aspect of human nature is yelling, “SELL!!!!”.  This is because our fight or flight response kicks in and we almost can’t help our reaction.   Yet, this simply create more and bigger issues.  We now add market timing risk or the risk associated with trying to get into and out of the market at exactly the right now.  We will inevitably get it wrong.  Per the recent market volatility at the end of Feb 2020/beg of Mar 2020 shows us, large ups and downs are often found in close proximity to each other.  The other major issue that this creates is additional cost.  Every time that we create transactions - there are added costs:  fees, bid-ask spreads, commissions are a few examples of how these could manifest.


So what do we do?  Consider working with a professional.  Create a balanced, diversified portfolio that fits your risk level and periodically and systematically rebalance. Have a financial professional help hold you accountable.  You will have questions, you will want to do the wrong thing (it’s human nature) and it’s critical that you have someone who can help put together a comprehensive strategy to coordinate your investments across accounts.


Alex Collins is a Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). OSJ: 3585 Maple St #140, Ventura, CA 909-399-1100. Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is a wholly-owned subsidiary of Guardian. Quantified Financial Partners is not an affiliate or subsidiary of PAS or Guardian. This material contains the current opinions of the author but not necessarily those of Guardian or its subsidiaries and such opinions are subject to change without notice. Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. Material is for educational purposes only.  By providing this content we are not undertaking to provide any recommendations or investment advice regarding any specific account type, service, investment strategy or product to any specific individual or situation.   Please contact a financial professional for guidance and information that is specific to your individual situation.   All investments contain risk and may lose value. AR license #7264699 CA License #OH24806 # 2020-98668 Exp 04/2022