3 Golden Rules to get ahead in reaching Financial Independence
As first published on Bankeronwheels.com
My Golden Rule — Keep at least 90% of savings in Proven Investments and ‘play’ with the rest
Percentage of My Assets allocated to Stock Picking
“It takes a huge investment in introspection to learn that the thirty or more hours spent “studying” the news last month neither had any predictive ability during your activities of that month nor did it impact your current knowledge of the world.”
Nassim Nicholas Taleb, Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets
OK, SO HOW DO YOU MANAGE THE 90% ?
I essentially follow 3 simple rules, that are easy on paper but hard to implement for people looking for instant gratification (which today’s society is all about)
#1 I don’t allow myself to lose the 90%
Exponential consequences of losses (Never lose money!)
#2 I let time be my biggest Ally
One reason why Buy & Hold pays off (and Warren Buffett keeps winning)
Einstein famously said compound interest is the 8th wonder of the world. You understand that people who bet on single name stocks won’t be able to outperform in the long term. They may also quickly lose money. As a result they are incurring a massive opportunity cost. Einstein concluded: “He who understands it, earns it … he who doesn’t … pays it”
Buffett’s first rule is based on that concept. “My wealth has come from a combination of living in America, some lucky genes, and compound interest.”
#3 I focus only on things that are in my control
Why do most people fail at investing? (You can’t time the market!)
Buy and Hold is probably the toughest investing strategy. Emotions always want to take control. Investors (sophisticated or regular savers) think they can time the market.
Th below graph is a sobering reminder of the potential costs of market timing. By missing some of the market’s best days, investors can lose out on critical opportunities to grow their portfolios with devastating results. Six of the 10 best days occurred within two weeks of the 10 worst days. This study shows that over 20 years, the average investor has achieved a 1.9% annualized return as compared to over 5.5% just by staying invested in an Index Fund (before fees)
20 year annualized returns by asset class 1998–2018
… and waste time on things over which they have an illusion of control
- Perhaps, you follow Stoic philosophy or did meaningful research and understand there are lots of aspects in investing (and life!) you have no control over (despite what most investors think). I try not to ignore the role of randomness in markets
- Did you know that the Pareto Principle also applies to investing? What does it mean? Stock picking has almost no influence over long term returns. It’s been researched heavily and proven correct. Crucially, the decision whether you allocate 60% to Equities as a whole (e.g. S&P 500) and 40% to Bonds will matter much more than picking individual stocks (in fact, allocation to the right asset class determines over 90% of overall investing performance)
10% for Stock Picking because it’s is fun but it’s a loser’s game
You want to pick stocks; you want to invest in the technology sector because you work in the technology sector. You want that dividend stock that you think will do well. You want Tesla or jump of the latest trade from El Presidente (that said he still only gambles with 5% of his net worth!)
Even among some of the smartest Retail Investors within Bogleheads and FIRE Community some are taking a gamble from time to time.
But remember to follow the below process with the 90% and you will be ahead in reaching Financial Independence
