Verruggio’s Essential Rules of Investing

Charless

Today I am featuring a guest blogger on “Persuasion Time.”  He is Charles Verruggio, one the senior advisors working at my firm.  He is also a voting member of our company’s Investment Policy Committee.  Investors and would-be investors would do well to lend an ear to his good advice.

1. Start Early (and remember to rebalance)

Taking advantage of the power of compounding is probably the most important rule when it comes to being a successful investor.  In theory, it should be the easiest as well.  Consider the following:

If you had invested $100,000 on 1/01/81 (in a pre-tax account) and split the money 70/30 between stocks (S&P 500) and bonds (Barclays Aggregate Bond Index) and never rebalanced, your total would have been $3.098 million (before tax) after 34 years (1/01/15). If you rebalanced back to a 70/30 split at the end of each year, your total would be $3.173 million (before tax) as of 1/01/15, i.e., $75,000 more. The Barclays Aggregate bond index, calculated using 6,000 publicly traded government and corporate bonds with an average maturity of 10 years, was used as the bond measurement (source: BTN Research).

This example also illustrates the importance of rebalancing

2. Stay Diversified

Although some individuals do indeed get rich off of a very concentrated position of one particular company (think employees with company stock options), the vast majority of individuals are more likely to do better with a balanced, well-diversified portfolio of stocks and bonds.  Diversification will help in the quest to preserve capital and reduce risk.  One simply needs to look at the Callan Periodic Table of Investment Returns to determine that it is nearly impossible to know in advance which asset class will lead the way in any given year.

Armed with this knowledge, one can easily see that diversifying across asset classes and market capitalizations can help protect one’s portfolio from experiencing the violent swings associated with a more concentrated portfolio, with only a few stocks in it.

Callan

3. Keep a long-term time horizon

A long-term time horizon allows one to withstand the inevitable volatility that the stock market displays from time to time.  Consider the following:

In the past 60+ years there has not been a 20-year period where the rolling stock market return has been less than 6%.  This is to say, had someone invested in 1931 or later and left the funds invested in the market for 20 years or more, they would have achieved an annualized total return of 6% or more in every single one of these 60+ twenty year periods.  To put this statistic in perspective, if an investor had put $100,000 in the stock market at any time from 1931 onward, and left this sum of money invested for 20 years or longer, the absolute minimum an investor would have is $320,713 at the end of the 20 years.

As legendary investor Warren Buffett says, “My favorite holding period is forever.”

4. Keep it simple

Speaking of Warren Buffett, keeping it simple is one of his favorite investment rules.  As he says “there seems to be some perverse human characteristic that likes to make easy things difficult.”

If an investment product or approach seems extremely complex, it is likely that the results may cause serious damage to the value of your portfolio.  Think of the Long-Term Capital Management (LTCM) debacle.  A famous bond trader brings together a team of other all-star traders and academics in an attempt to profit from the vast intelligence of this so-called “dream team.”  Less than 4 years later, the fund had lost more than 90% of its original investment and the Federal Reserve felt compelled to organize a bailout of LTCM, encouraging 14 banks to invest $3.65 billion in return for a 90% stake in the firm.  During this entire crisis, LTCM posed a serious threat of a systemic crisis to the world financial system!  This example brings to mind the “smartest guy in the room” types who outsmarted themselves into catastrophic losses.