Investing is one of the most effective ways to achieve major financial goals like homeownership or retirement. Successful investing relies on having clear guidelines, or principles, that shape your investment strategy and keep you focused on your objectives.
Since every investor has unique goals, each person also develops distinct investing principles. This guide will explain how to create your own investing framework and highlight widely-used guidelines.
What is Investing?
Investing means putting money into assets or projects you expect will generate returns over time. It’s one of the most powerful ways to make your money work for you, building wealth and helping you reach major financial milestones.
While many investors think only of the stock market, investing encompasses much more. The investment universe includes tradeable assets like bonds, savings accounts, and even businesses. Regardless of where you invest, having guiding principles is crucial for making sound investment decisions.
What is an Investing Principle?
An investing principle is a rule or guideline that directs your investment decisions. When choosing investments or crafting an investment strategy, you should reference your principles to determine how to proceed. These principles should clearly align with your financial goals and help maintain your focus on achieving them.
Why Do You Need Investing Principles?
Investing principles serve two critical functions in your investment journey.
First, they help shape your investing strategy. When deciding what to invest in or evaluating whether a particular investment fits your portfolio, you can turn to your principles for guidance.
Second, investing principles ensure you act with purpose, making certain that every decision moves you closer to your financial goals. Whether navigating market volatility or considering a risky investment, consulting your principles keeps your long-term objectives front and center.
Your Investing Principles
Every investor is unique, with different goals and risk tolerances. One person might invest aggressively for additional income, while another takes a conservative approach for retirement. While common investing principles exist, no two investors will use identical rules for their investment approach.
Regardless of your investing goals, developing personalized principles is essential. Use popular investing principles as a starting point, but customize them to fit your specific needs.
Popular Investing Principles
When creating your own investing principles, examining guidelines used by experienced investors is valuable. Here’s a selection of proven investing principles to consider.
Have a Plan
One fundamental rule successful investors follow is having a clear plan for every investment. Before investing, establish a strategy that outlines your holding period, expected returns, and the maximum loss you’ll tolerate before selling.
Know Your Risk
Understanding your risk tolerance is fundamental to successful investing. Determine the maximum loss you can accept on any single investment and never exceed that threshold. For example, if a 20% loss is unbearable, plan to sell when an investment drops 10% or 15%.
If you establish selling rules for losing investments, stick to them. It’s tempting to hold onto declining investments emotionally, hoping for a recovery. For stock investments, consider setting automatic stop losses to remove emotion from the decision.
Invest Early
Starting early is as crucial as investing wisely. Money invested compounds over time—the longer it remains invested, the more wealth you’ll accumulate.
To illustrate compounding’s power: investing $10,000 at age 30 with a 7% return yields $38,700 at age 60. However, investing that same $10,000 at age 20 would result in $76,100 at age 60. Starting early can dramatically enhance your financial position down the road.
Invest Regularly
Beyond investing early, maintaining regular investments offers multiple advantages. First, you maximize compounding by investing frequently rather than waiting. Second, regular investing builds healthy saving and investing habits. Finally, consistent investing enables dollar-cost averaging—investing during both favorable and unfavorable market conditions to match overall market performance.
To establish regular investing habits, set up automatic transfers to your brokerage account or create monthly calendar reminders.
Diversify
Portfolio diversification is a cornerstone of smart investing. Diversification means spreading investments across different asset types and economic sectors.
Diversification follows the principle of “not putting all your eggs in one basket.” This approach allows investors to reduce risk through broader market exposure. For instance, a portfolio invested entirely in tech stocks will mirror the tech industry’s performance exactly—beneficial during tech booms but problematic during downturns. Diversification across industries helps mitigate single-sector dependency.
You might diversify by investing across stocks, bonds, and real estate, or by selecting stocks from different sectors like automotive, technology, and healthcare. You can also diversify within sectors or asset classes.
Here are some examples of diversification:
- Diversification of Asset Classes – Mix of stocks, bonds, and real estate investments.
- Diversification of Sectors – Mix of stocks in different sectors like technology, consumer staples, and utilities
- Diversification Within a Sector – Mix of stocks within a sector. For example, in tech, you could buy chip makers, online services, electronics manufacturers, etc.
If you’re unsure which stocks to include in your diversified portfolio, you can leverage expert research. For example, Motley Fool Stock Advisor provides two new stock picks monthly, plus a list of 10 starter stocks that can serve as a strong portfolio foundation (available at a discount for new members).
You can also hedge your investments. If you’re heavily invested in stocks, consider significant investments in different asset classes like real estate. Alternatively, maintain cash reserves in high-interest savings accounts to capitalize on market downturns.
Don’t Try to Time the Market
Many investors attempt market timing, but research consistently shows very few succeed at this strategy. It’s generally better to focus on investing early and consistently rather than trying to time market movements. The more time you spend in the market, the more likely you are to match its performance and benefit from compound interest.
Minimize Fees
Investment fees accumulate quickly and can significantly erode your returns. Financial advisors, brokers, mutual funds, and ETFs all charge fees that can reach several percent of your investment. Since a 10% annual return is considered excellent, fees of 2-3% can be substantial.
Always review fees associated with every investment and carefully consider whether those costs are justified.
Ignore the Noise
Investors face constant information overload—from economic forecasts to financial news to investor rumors and advice. This information can be overwhelming, so staying focused on your strategy is crucial. Simply ignore or set aside any information that doesn’t directly support your investing strategy.
Rethink and Rebalance
Investing remains dynamic—markets rally or crash, and your financial goals evolve. When circumstances change, pause to evaluate whether your investing strategy remains appropriate. If not, don’t hesitate to adapt it to new conditions.
Invest for the Long-Term
It’s easy to get caught up in daily market fluctuations. But when investing for goals years away, these short-term movements are largely irrelevant. Ignore daily price changes and focus on the time horizon that matters for your investments.
Conclusion
Establishing a set of investing principles is essential for every investor. These principles help shape your investment strategy and maintain focus on your financial goals throughout your investing journey. Use proven investing principles as your foundation, but ensure the principles you adopt align with your specific investing approach.
