Wednesday, February 16, 2011

Investing 101

Today marked a special day in that the S&P 500 doubled since the 2009 market crashed.


As those scared by the great crash in late 2008 and losing money like the waterfall that it was, investors would have been out over 50% of their investments. From a high of 1400 in 2008 to a low of 680 in 2009. I was certainly one of them. Who knows what's going to happen... the market could have dropped to 400 or lower.

Today, the beginning of 2011, the headlines on Google Finance says:


So who do you believe? Do you believe that when the market drops 50% in less than a year you should GET OUT AS SOON AS POSSIBLE or do you say to yourself FIRESALE, BLUE LIGHT SPECIALS, 50% OFF SALES?

I think the mentality of investors having a short term mindset, i.e. daytraders, week (weak) traders will definitely jumpship. But with your retirement plan, you are going at it for the long haul. Companies rise and fall not because of the stock market, but because they have a good product they are selling, people are buying it or using their services.

That's why when the market goes crazy and yells SELL! SELL! SELL! As an investor, you need to ask yourself, where are the opportunities that people are missing.

I've posted in the past some books I've read and some investors that have made some good money because they found good companies to invest in... Intelligent Investors.

Here are two quick principles I've learned over the past ten years of investing. I started in 1999 when the market was going crazy and seen the ups and downs in the 2000s. My father is an investor and he's been at it for 30+ years and I also chat with my sister and brother about investing, but here goes.

Two BIG principles you HAVE to keep in mind when investing. These are basic principles I have to always remind myself while investing.

1. INVEST FOR THE LONG HAUL

Having a long time horizon means that you can't expect 100% returns every year. You also can't expect it to be positive every year, but historically, the market has been positive more years than it has been negative. Those with long term perspective can ride out the short term turbulence especially when Macroeconomics and Foreign Trade and Commodities and China and foreign debt all can affect a day or a quarter or even longer how the stock is being traded.

By having a long time horizon, you can better let your investments ride. So when you have a 10% or 20% or even 30% drop, you won't pull the trigger, but instead see what opportunities you have for long term growth in such situations.

Which means when you are investing regularly, you dollar cost average and buy when stocks are going down as well as when they are going up.

2. DIVERSIFY YOUR PORTFOLIO

This principle has been debated vigorously. I'm sure you've seen the charts. Some years small caps do well, other years gold does well, other years Real Estate does well. You can predict some of the things happening through Macroeconomics big picture stuff like:

1. America has huge debt, which means we borrow money or print more money, in any case the value of the dollar goes down, which means prices of commodities goes up, especially precious metals or

2. there's greater growth in China, so there will be greater demand in commodities like copper, oil, steel, agriculture and other stuffs, or

3. interest rates are rising making it harder for smaller companies to borrow which means large caps with large cash holdings will do better, housing market will slow, housing prices will stabilize or go down due to lesser demand, etc. etc. etc.

But what we don't know is when these things are going to take place. We are not psychic and most investors try to forecast when things will happen, but like weather people, forecasts are only as good opening your door and looking outside.


This chart is a little bit outdated, but you can see that no two years had the same returns. Some did better than others. One year it's real estate, another it's large caps, other years it's commodities. You get the picture. Diversify is your best bet for a winning portfolio.

Why are people against diversifying? Well, it actually hinders you from maximizing your gains. If for example I placed all my money in Small-Caps Growth in 1999, I would have returned 43%. But if you diversified, you would have made about 15%. Not bad but not as good as 43%. So you sacrifice some return for risk. You're hedging some risk. My example is roulettes. You can choose black 29 every time and once in a while it'll pop up, but if instead you place your bet on Black you'll have a greater chance of winning but you'll get a far smaller return.

So I say diversify, it's a safer bet and it's a smarter bet.

I say a good index fund like the S&P 500 or Russell 2000 and for international exposure something like the EAFE index.

I'll post more insights on investment once I read some of these books I borrowed from the library, so stay tuned.

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