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20 Rules for Markets and Investing

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Turn the insights from Charlie’s 20 Rules into results for your financial future.

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My 20 Rules for Markets and Investing…

1) Be Humble

Having more confidence is a good thing in many areas of life. Markets are not one of them. More confident investors tend to trade more and take on undue risk, leading to worse performance.

As Paul Tudor Jones once said: “Don’t be a hero. Don’t have an ego. Always question yourself and your ability. Don’t ever feel that you are very good. The second you do, you are dead.”

2) Don’t Trust, Verify

Enticingly high yields. Smooth returns. Perfect market timing.

These are just a few of the siren songs that can lead investors astray.

Take a look at the second column in the table below:

  • No down years from 1990 to 2008.
  • 10.6% annualized return with less volatility than bonds.
  • A maximum drawdown of less than 1%.

Does that seem too good to be true?

It was. These were the fake returns of the largest feeder fund invested with Bernie Madoff. Billions and billions of dollars, chasing what appeared to be risk-free reward.

3) Play the Long Game

On any given day in the stock market, your odds of a positive return are just 53%, little better than a coin flip. Increase your time horizon to a year, and your odds of success jump to 75%. At a 20-year holding period, there has never been a negative return for U.S. equity investors.

The big money is made in the big move. The most important lesson from perhaps the most famous trading book of all time (Reminiscences of a Stock Operator) had nothing to do with trading…

It never was my thinking that made the big money for me. It always was my sitting.

4) Understand That Every Time Is Different

Prior to 2020, the shortest bear market in history was just under 2 months, with the S&P 500 declining 36% during the 1987 crash.

But on March 23 of 2020, the S&P 500 was down 35% in a little over a month. At the time, the entire world was on lockdown and the US was said to be facing an economic collapse reminiscent of the Great Depression. One would have reasonably assumed that there had to be more downside to come.

But there wasn’t. The S&P 500 started rallying the very next day (March 24) and never looked back.

A new shortest bear market in history was born (33 days), with the market back at all-time highs by August.

5) Pay No Need to Predictions and Price Targets

Investors love few things more than price targets.

Why?

Because they give certainty (a specific number on a specific date) to an inherently uncertain endeavor (investing).

Each year, Wall Street is more than happy to give the people what they want. These were the 2020 year-end price targets from some of the largest firms…

Amazingly, they all ended up being below the actual year-end number (3,756) despite the fact that we had a global pandemic, the largest quarterly contraction in the economy ever, and the highest spike in the unemployment rate since the Great Depression.

Who could have foreseen these events and the subsequent market reaction?

No one, which is precisely the point.

6) Embrace Risk

Risk often has a negative connotation, but you can’t ignore the fact that without it there would be no reward. That concept applies to many aspects of life — and most certainly to investing.

If you’re a long-term investor, some amount of higher risk and volatility needs to be embraced if you want to earn a higher return than cash.

In years like 2022, when stocks and bonds go down together, it’s tempting to shun all risk.

But in the long run, not taking enough risk can be the biggest risk of all, as your purchasing power will be eroded from the constant drumbeat of inflation.

7) Buy the Haystack

Musk. Bezos. Gates. Zuckerberg.

A list of the wealthiest Americans all have one thing in common: concentration in a single company’s stock that they founded.

It’s tempting to believe that is the model you should follow in your own investment portfolio, but for most, that would be a mistake.

Why?

Because the odds of you picking a single stock and it becoming one of the big all-time winners are not in your favor.

A majority of companies (59%) underperform Treasury bills over their lifetime and more than half end up having a negative cumulative return.

But that’s not the worst-case scenario. Any individual stock can go to $0, as we see each and every year.

An extremely small number of stocks (72 out 28,114) are responsible for half of the market’s wealth creation over time.

Which means that if you’re picking just a handful of stocks, you’re likely to exclude one of these big winners and underperform the market as a result.

This is one of the many reasons why most professional money managers (>90%) underperform their benchmarks over the long run.

As Jack Bogle once said: “Don’t look for the needle in the haystack. Just buy the haystack.”

8) Fight the Fed

One of the most repeated maxims in investing is the saying “don’t fight the Fed.”

The implication: you should not be long stocks when the Fed is tightening monetary policy.

So it probably came a surprise for many to see the S&P 500 gain 35% from March 2022 (when they started hiking rates) through September 2024 (when they started cutting rates).

But did this example run counter to the historical record? Not at all.

On average, stocks have posted positive future returns regardless of Fed policy. And looking ahead 10 years, the stock market has actually has done its very best following periods with the highest Fed Funds Rate (both on a nominal and real basis).

Which of course means that monetary policy is just one of many factors influencing stock prices, and a highly overrated one at that. Ignoring Fed moves and fighting Fed narratives has historically been the best strategy for long-term investors.

9) Expect the Unexpected

Given enough time, the market will make a fool out of anyone basing their expectations for the future on what has happened in the past.

Why?

Because financial markets do not follow a bell curve. Instead, they operate in the world of fat tails, where extreme events are much more likely to occur than a normal (or Gaussian) distribution would predict.

This year’s prime example?

A 17.5% crash in Japan’s Nikkei 225 Index over the course of 2 trading days. This was the biggest 2-day decline in the history of the Japanese equity market and a 10 standard deviation event.

Using statistical forecasting based on all prior data, this should never have happened even once in the history of the universe. But it did, and given enough time, it will happen again.

10) Don’t Chase the Past

“What are the past returns?”

That’s the first and often only question many ask before making an investment.

Why?

Because we’re wired to believe that those returns are indicative of what we’ll receive in the future.

If an investment has gone up 25%, we expect another 25%.

If an investment has doubled, we expect it to double again.

If an investment has gone up 10x, we expect it to be a 10-bagger once more.

The more extreme the performance, the more emotionally charged we get, and the more likely we are to start chasing past returns at the worst possible time.

In the five-year period from 1995 through 1999, the Nasdaq 100 gained 817%, an annualized return of over 55% per year. Tech stocks were all the rage, and many new investors were buying in with the expectation of similar future gains.

What happened next?

The Nasdaq 100 fell over 56% in the subsequent 5 years, an annualized return of -15% per year.

11) Focus on Saving Before Investing

Investment returns get all the attention but for most people, how much they save is much more important.

Why?

Because most people don’t save very much at all, and without savings you cannot invest. That’s true whether you make $50,000 a year or $500,000 a year. If you spend everything you make, there’s nothing left to invest.

Over 30 years, saving 10% of your income with a 1% rate of return handily beats a 10% return with a 1% savings rate.

Note: Table Assumes No Taxes on Investment Gains and Constant Disposable Income of $68,000 per Year.

If you’re saving very little today, all of your focus should be on saving more. Why? Because the long-term gains from a higher savings rate will trounce the gains from earning higher returns.

For instance, if a household with a disposable income of $68,000 only saved 1% per year and earned a 5% return, after 30 years they would have $45,178. Earning a 6% return would bump that up to $53,760, a 19% increase.

By comparison, if their returns stayed at 5% but they were able to save 1% more per year (2% savings rate), they would be left with $90,357 after 30 years. That’s a 100% increase in the ending balance through saving 1% more versus a 19% increase from earning a 1% higher return.

Clearly, savings seems to trump investing returns for the average American household. And this is great news, for saving more is something you actually can control, whereas earning a higher rate of return is infinitesimally more difficult.

12) Simplify Whenever Possible

“You get what you pay for” is often a valid assertion, with cheaper goods or services more likely to be inferior.

Many assume the same logic should apply in the complicated world of investing and Hedge Funds are happy to fill that void, charging a handsome fee in the process.

Over the last 15 years, how have long/short equity hedge funds fared relative to a simple 60/40 portfolio of stocks ($SPY) and bonds ($AGG)?

Lower returns (117% vs. 295%) with higher fees, less liquidity and far more complexity.

In investing, you don’t always get what you pay for. Whenever possible, try to keep costs down and simplify.

13) Learn to Be Good at Suffering

Since 1928, the US equity market has generated a cumulative total return of 783,563%.

What’s the catch?

It wasn’t a straight line higher – far from it. An investor in US equities would have been in a drawdown over 90% of the time.

I know what you’re thinking. There has to be a better way. You want the tremendous upside without the downside.

We all do. The only problem: in trying to time or hedge your exposure, you will likely miss out on a substantial portion of the gains.

To reap the biggest rewards you must be able to take the painful hits and keep moving forward. Which is why the ultimate superpower in investing is being good at suffering.

14) Never Interrupt Compounding Unnecessarily

When Warren Buffett turned 94 this year, his net worth stood at $148 billion.

An incredible number, to be sure.

But even more incredible is the fact that 98% of that was generated after he turned 65.

Compounding can produce amazing results over long periods of time.

In the last 10 years, a $100,000 investment in the S&P 500 would have grown to $356,000. That’s a 13.5% annualized return, or 256% cumulative gain.

But this assumes you bought in 10 years ago and held on through good times and bad. Many did not, as evidenced by the record $326 billion pulled from equities during the March 2020 Covid crash.

For those that sold in the March 2020 panic and did not get back in, the cumulative return over the last 10 years was just 29%. The same $100,000 initial investment would grow to only $129,000.

As Charlie Munger once said, “The first rule of compounding is to never interrupt it unnecessarily.”

15) Tune Out the Noise

Investors are bombarded with noise on a daily basis and at times that noise can become almost deafening.

In August 1979, BusinessWeek ran a cover story entitled “The Death of Equities,” with the author arguing that “the old attitude of buying solid stocks as a cornerstone for one’s life savings and retirement has simply disappeared.”

Over the next 20 years, the S&P 500 would increase 2,375%, a 17.4% annualized total return.

The financial media’s primary job is to entertain, generating as many views and clicks as possible. Your job as an investor is to tune them out.

16) Respect Reversion to the Mean

When volatility spikes and fear abounds, it can seem as if the bad news will never end.

But time heals all fears and good news is on the horizon.

When the rubber band gets stretched, it tends to snap back violently in the opposite direction.

As Jack Bogle once said: “reversion to the mean is the iron rule of the financial markets.”

17) Know What You Own and Why You Own It

You can have the best portfolio in the world but if you don’t understand what’s in it, you will abandon it at the first sign of trouble, and fail to reap the long-term rewards from compounding.

As Peter Lynch once said, you need to “know what you own and why you own it.”

You own stocks to participate in the growth and ingenuity of human beings and enterprises over time. Your goal: to outpace inflation and earn a higher return than bonds.

If stocks never went down there would be little need to own anything else.

But as we know, they do go down from time to time. Since 1976, there have been 8 calendar years in which stocks have finished lower: 1977, 1981, 1990, 2000, 2001, 2002, 2008, 2018, and 2022. In each of these years, bonds outperformed, cushioning the blow.

A position in bonds allows investors to better withstand big stock market declines and to ideally rebalance back into equities at lower prices/valuations.

Bonds also give investors the ability to meet short-term liquidity needs without having to sell down their stock portfolio.

How much of your portfolio should you have in stocks, bonds, and cash?

There’s no one-size-fits-all answer to that question because it depends on your time horizon, tolerance for risk, and needs/goals for the future. Every investor is different, but what’s universal is the need to know what you own and why you own it.

18) Diversify, Diversify, Diversify

If you could predict the future, you would of course hold only the best performing asset class.

Over the last decade, that would have meant a portfolio concentrated only in U.S. large cap growth equities.

But because no one can predict the future, you probably didn’t own such a portfolio. And that’s ok, because real diversification means not everything in your portfolio will be “working” at the same time.

There’s a cycle to everything in the markets; nothing outperforms forever.

At the end of 2009, many were bemoaning the “lost decade” in which the S&P 500 Index declined 9% and the Russell 1000 Growth Index lost 33%. It may seem hard to believe, but back then investors were questioning whether large-cap U.S. growth stocks would ever regain their footing.

Will the next decade for investors look exactly like the last one?

Probably not. The leaders and laggards in markets are forever changing, and the best protection against our inability to predict them is to diversify, diversify, diversify.

19) Control Your Emotions

Fear and greed are primal emotions. We’re wired to respond to them. That has served us well from an evolutionary perspective but in investing they do more harm than good.

When markets are falling, we fear losing everything and are induced to sell to stop the pain.

When markets are rising, we fear missing out on future gains and are driven to buy to end the regret.

When tempted to act based on fear or greed, step away. Take a deep breath, go for a long walk, read a book, or watch your favorite movie. The market will be there when you get back and you’ll be in a better state of mind to make any decision.

20) Value Time over Money

Prudent asset allocation is the foundation of a successful long-term investment plan while prudent time allocation is foundation of a successful long-term life plan.

Investors often think about the former, and rarely give thought to the latter.

No amount of money can buy the past. Focus more on the latter and prioritize the things that matter most to you.


Every week I do a video breaking down the most important charts and themes in markets and investing. Subscribe to our YouTube channel HERE for the latest content.

Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. Read our full disclosures here.

The post 20 Rules for Markets and Investing appeared first on Charlie Bilello’s Blog.





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