A Review: WSJ “Five Bedrock Principles for Investors”

In a recent article in the Wall Street Journal Five Bedrock Principles for Investors, Morgan Housel reviewed five principles investors can use to maximize the long-term returns from their portfolios. Given the volatility of the markets over the past year, we thought a review of these principles would serve as a timely reminder that “most of what matters in investing involves bedrock principles, not current events.”

• Principle #1: Diversification is how you limit the risk of losses in an uncertain world.
  • This principle isn’t news to a Yeske Buie Client – diversification is a foundational piece of our investment philosophy. Housel notes that “diversification among different assets can be frustrating. It requires, at every point in time, owning some unpopular assets.” And why would you want to own these unpopular assets? “Because the future will play out in ways you or your advisor can’t possibly comprehend.” We couldn’t agree more. As we’ve noted in past posts (How to Invest When Your Crystal Ball is on the Fritz, How to Build an All-Weather Portfolio and March 25, 2015 Year-to-Date Market Update) there’s no reliable way to consistently pick winners in the markets; instead, we focus on owning a globally-diversified portfolio to minimize risk.

• Principle #2: You are your own worst enemy.
  • This principle is best illustrated in our investment philosophy through our disciplined approach to rebalancing. Housel posits “the biggest risk investors face…is their own emotions and biases, and the destructive behaviors they [can] cause.” To eliminate this risk, we set boundaries around each position in our Clients’ portfolios; as soon as something has grown or shrunk such that it crosses a boundary, we make the corresponding trade to “buy low” or “sell high.” Doing so takes the emotion out of selling something that has been performing well or buying something that hasn’t kept up.

• Principle #3: There is a price to pay.
  • Housel uses an analogy to illustrate this principle: “the price of admission to earn high long-term returns in stocks is a ceaseless torrent of unpredictable outcomes, senseless volatility and unexpected downturns.” We’ve previously commented on the notion that you have to “pay to play” and maximize the returns your portfolio will generate in our post, The Only Game in Town; this is the outcome of the interplay between risk and return, and is very clearly illustrated by the volatility of the stock market, as stocks are the riskiest asset an investor can own. Housel hits the nail on the head to summarize this principle: “the reason stocks offer superior long-term returns is precisely because we can’t forecast what they will do in the short run.”

• Principle #4: When in doubt, choose the investment with the lowest fee.
  • This principle (among a host of other reasons) is behind our choice to use Dimensional Fund Advisors (DFA) as the primary source for the mutual funds we employ in our Clients’ portfolios. Here’s Housel: “as a group, investors’ profits always will equal the overall market’s returns minus all fees and expenses. Below-average fees, therefore, offer one of your best shots at earning above-average results.” The average retail mutual fund’s internal expense ratio hovers around 1.5%; in contrast, the DFA funds we use carry expenses that average less than 0.4%. How much is that extra percentage point worth? If you invested $100,000 today, made no additional deposits and it earned an average of 9% over a 40-year period, it grows to $3,100,000; if the same $100,000 earned 10% over the same period, it grew to $4,500,000.

• Principle #5: Time is the most powerful force in investing.
  • Housel uses the Oracle of Omaha, Warren Buffett, and his investments’ performance to illustrate this point: “wealth grows exponentially – a little at first, then slightly more, and then in a hurry for those who stick around the longest.” This principle reminded us of the super-power that all young investors have on their side: time! Every good financial decision made by a young person is exponentially more valuable due to the time value of money, which is why we feel our Financial Literacy program is such a crucial initiative (read more about Yeske Buie’s Financial Literacy Program). And it’s never too late to start!