Financial Geekery

defeating your worst enemy

September 18, 2012

Last week, we talked about how your own worst enemy when it comes to investing is yourself. So how does one go about defeating an enemy so subtle, so intelligent, and so very…you? Well, here are a few systems that can help.

 

Have a written plan, and a regular date in your calendar for reviewing it. Whatever your plan is — whether you’re a businessman or an academic — write that plan down. If you don’t have a written, solid plan, it’s a good bet that you’re going to let your emotions change that plan whenever you feel like it. If the market crashes, it’s too late — if you sell then, you’re just buying high and selling low! So write a plan, review it once every 6-12 months, and only change the plan when it’s up for review. This will keep you from trying to chase performance and falling victim to that dreaded Behavior Gap.

 

In particular, have a systematic rebalancing plan. If your investing plan is asset allocation based — and I recommend that it should be — make sure you regularly check to see if it needs rebalancing. Notice that I said “check”; don’t just mindlessly rebalance every quarter, or trading costs could eat any gains you may have gotten. No, it’s better to have a concrete plan in place, with rules like “if the absolute percentage of international stocks is more than 5% from the target, rebalance” or “if any individual stock becomes more than 2% of my portfolio, rebalance”.

 

Stick to the Yahoo principle. William Baldwin at Forbes wrote an article in which (along with recommending fee-only advisors) he outlines the Yahoo principle: buy things that trade in large volumes with prices you can see. Read the article for his reasoning, but I only needed one story to convince me: a friend of mine, incredibly intelligent, who had been investing since before college, had money tied up in some fancy dutch-auction securities which, after 2008, simply would not sell, at any price. Sure, nothing ventured, nothing gained, but there’s such a thing as the reward not being worth the risk.

 

Once a year, run the Overnight Test. This gem comes from Carl Richards. The idea is simple: once a year, imagine that one night, some crazy guy took all your assets and liquidated them, but left the proceeds in your account, so you wake up and find that everything you have is in cash. What would you buy? If it’s not the securities you currently own, why do you still own them?

 

These are some of my favorites, but it’s by no means an exhaustive list. How about you? What are some of your favorite systems?

 

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