Today I’ve got a guest post by Troy from MarketHistory.org. Troy is a hedge fund manager whose fund is closed to outside investors. In his spare time he surfs around Sydney and blogs at http://markethistory.org/blog. Thanks for reading!
As the years go by, certain investment rules become outdated. For example, diversification among stocks for the sake of capital gains is semi-irrelevant nowadays. Stocks are highly correlated (so there is little diversification in buying many stocks), and it’s proven that few stock pickers outperform the index over the long term.
However, there are some rules that still apply and will always apply. Investors who follow these rules tend to perform better than investors that don’t in the long term.
Sit tight and be right in a bull market.
A lot of investors who want to outperform the market will jump in and out of the market during a bull market. Unless you develop models to predict the big corrections like we do, your timing probably won’t be great. So perhaps you’ll sell in anticipation of a correction, watch the market soar 20%, then watch the market fall 10%, and then buy. Instead of “buying on the dip”, you just bought a price that’s 10% higher! The key to making money in a bull market is to ride the bull until it turns into a bear market. Buy and hold as long as it’s still a bull market. If you want to outperform the market, feel free to buy leveraged ETF’s. That’s what we do. A leveraged ETF will multiple all of the market’s gains and losses by 2x or 3x. The good thing is that a leveraged ETF can never go below zero. So if the market falls 40%, a 3x leveraged ETF will not go to -20% territory. That’s just based on how the ETF is calculated.
Never, ever short the market.
There are some perma-bears like Jim Chanos who always play the short side of the market (profiting from declining prices). Shorting stocks is a very dangerous long term strategy and I have seen hedge funds blow themselves up that way. For example, a friend of mine shorted silver when it was at $25 in 2010. It promptly went to $50 in 2011 and his fund lost a lot of money. Legendary hedge fund manager Julian Robertson closed his fund in 2000 after disastrous losses from shorting tech stocks in 1999. Markets have a bullish bias in the long run. So playing on the short side effectively pits you against long term market forces. The economy grows more often than it contracts in the long term, which means that corporate earnings grow over time. Growing corporate earnings are what drive stock prices higher in the long term.
There are times when you should shrink the size of your investments.
There is no point in being fully invested when stocks are ridiculously overvalued. Sure you can convince yourself that you’re a “long term investor”. But “long term” does not mean 20 years. It means 5-10 years. How many investors can really stomach a 50%+ loss on an investment? If you bought stocks in 2000 because you’re a “long term investor”, you would have waited 13 years before seeing any gains (the S&P effectively broke above its 2000 high in 2013).
Take a break when you’ve lost a lot of money on an investment.
Go on a vacation. This sounds counter intuitive (how am I going to afford the vacation?!), but it works. Investors who have just lost a lot of money usually have the “I want to make the money back ASAP” mentality. That is a very dangerous mentality because you are no longer thinking rationally. Instead, taking a vacation will allow you to step back and reassess the situation. What lessons did you learn from that mistake? How can you improve your investment strategy in the future? After coming back from that vacation, do not be in a hurry to invest your money. Wait for a good opportunity and then invest. A big loss tends to mess up your psyche, which adversely impact your investment decisions.
Follow the news, but don’t dive too deep into it.
It is important to stay abreast of the latest financial and economic news. Your market outlook will change as the macro environment changes. However, focusing too much on the day-to-day news will cause you to lose sight of the long term outlook. It’s very easy for the media to exaggerate the news. For example, ZeroHedge makes it seem as if the world is going to end every day and that we should just sell, Sell, SELL. If you read too much into the details, you too will start to believe that the market will “100%” crash tomorrow. The media prefers to put a bearish spin on news instead of a bullish spin because studies show that bearish news receives 5x more pageviews than bullish news.
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- While I do strive to only write accurate information and dispense valuable advice, I am not a licensed financial adviser. All information is based solely on my personal experience and personal research and should be treated as such. Find out more.