3 Core Principles To Guide Your Investment Decisions
If you are conversant with this blog you would have learnt that I like simple things. I like my investment process to be as simple as possible, I like writing to be as simple as possible and I like to do things that will allow me to have a night sleep. The downside to my simple lifestyle is that I may not make the highest return in the market but I can be sure that my capital can stand the storm and that over a long enough time, I will outperform more than 80% those who complicate investment decisions.
Don’t get me wrong, doing simple things has ramifications. It could be buying a low-cost Index ETF over and over again, it could be buying a specialized ETF or it could be a combination of both mentioned already. And yes, it could also be doing the hard work to find the next Amazon or Apple and averaging in on them for the next 20 – 40 years of my working career. The idea is that keeping one’s investment process as simple as possible has dividends that surpass the alternative.
To further my agenda of helping you get wealthy through the practice of investing, I want to share with you 3 core principles that should guide all your investment decisions. These are principles that will serve as a light for you every time you want to put money into something and when you want to get it out.
Whenever the issue of money comes up, our first instinct is always how do I make more of it. How do I double this amount of money in this short period? As Tony Robbins put it in his book, the best investors are obsessed with avoiding losses because they understand a simple but profound fact: the more money you lose, the harder it is to get back to where you started.
Let me put that statement in perspective for you. If you invest N100,000 and lose 50% of it, bringing your capital to N50,000, how much would you need to get back to N100,000? You may be tempted to say all you need is to make the 50% that you lose back. However, you would be wrong because turning N50,000 to N100,000 requires a 100% return. And 100% is an unprecedented number that may take up to 10 years depending on what you invested your money in.
This explains why Warren Buffett 2 rules of investing are, one, never lose your money and two, never forget rule number 1. The rules are instructive enough.
Never lose your money doesn’t however mean you should not invest your money at all or that you should avoid making more money in the name of not wanting to lose money. You would be wrong to think that way because even the Buffett himself is a legendary investor. So what does it mean to not lose money?
- Don’t invest in what you do not understand. Doing so would ordinarily force you to make investment decisions that will cost you money.
- Don’t risk too much of your capital.
- Define your investment strategy and stick with it
- Don’t chase the highest return in the market rather invest in what will give you a great sleep at night.
- Aim for being reasonable over being rational. Humans are emotional and we can’t be rational all the time but we can be reasonable all the time. That’s why I wrote this article on how to deal with the fear of missing out.
That’s not all but I’m sure those would give general guidance about things you can do to lose your money. High returns are good, doubling your money is fun. However, not losing what you’ve worked hard to earn is even more rewarding and it’s a lofty aspiration and easily attainable goal.
While I was learning corporate finance, what I was taught was that the higher the risk the higher the expected returns. In order words, I should not expect higher returns except I’ve assumed a higher risk. And I think there is an element of truth in that no doubt. Yet, one of the best things you can do for your investment is to look for opportunities where the reward is really high relative to the risk you are taking. It’s called asymmetric risk/reward.
Let’s use numbers a bit. Imagine you have N1m to invest and you take 10% of that (N100k) to invest in an asset that returns 500%. That is to say, your N100k investment is now worth N600k. Even if you only made a moderate 10% on the remaining N900k, your new net worth at the end of such period would have become N1,590k N(900k + 90k + 600k). On average, your investment had made a return of 59% on your invested capital.
The temptation when one finds an asymmetric investment is to want to bet more than what is reasonable and prudent. Remembering the first guiding principle should be a guide here. Asymmetry investments are not definite, just as much as they can increase greatly, they can also reduce erratically. That’s why putting a moderate amount of money is always the optimal hedge. Thinking about our example from above, if you lose 50% of the N100k, overall, your portfolio will still stand strong because your total balance at the end of this scenario would now be N1,040k N(900k + 90k + 50k). In which case you would have been true to the first principle of not losing your money.
And asymmetry investments are always available even though it is only the benefit of hindsight that makes them obvious. To mention a few, Apple, Microsoft, Tesla, Bitcoin, Starbucks are a few that will qualify for an asymmetry bet. The relevant question as you will agree with me is which investments are the next asymmetry bet? Well, they are always known absolutely until it’s too late. Keep an eye out is my response to that.
Are asymmetry opportunities only available in the public market? The answer is no. Some get their asymmetry returns from private investments like investing in startups, some times, it could be just a friend introducing you to something from nowhere but which you feel confident enough to invest in. It can come from anywhere.
The third one is obvious. We’ve all heard the statement “don’t put all your eggs in one basket”. But what does that mean? There’s a difference between blindly quoting a statement and knowing what it means plus doing it.
I learnt something interesting from Tony Robbins on the different kinds of diversification. I will share them with you because they are important.
There are 4 ways to diversify effectively:
- Diversify between assets within different classes (e.g., real estate, stocks, bonds, commodities, private equity)
- Diversify your holdings within asset classes (avoid concentrating putting all of your money into one stock or bond; you must diversify even within your asset classes)
- Diversify globally (e.g., markets, countries, currencies) – if you live in my part of the world where the currency depreciates very often, this point is even more important for you. Having some of your investment in a dollar-denominated asset, some Bitcoin, if you believe in it, would be a practical way of going about this.
- Diversify timelines (e.g., dollar-cost averaging, maturity date) – you are never going to know the right time to buy anything. But if you keep adding to your investment systematically over months and years (that is cost averaging), you’ll reduce your risk and increase your return over time.
All the principles mentioned so far are easy to repeat and read but doing them can be difficult. That’s the nature of simple things, they are difficult to implement but those who implement painstakingly are always rewarded. That’s why I like the wisdom of Charlie Munger when he said: “take a simple idea and take it seriously”. Doing so will put you in the top 10% of the world’s best I believe.