The Five Essentials
Making Sense of Investing
It is understandable that beginners find the subject of investing daunting and confusing. Where do you start? Are there guidelines? How do you make sense of it all? In addition to newer investors, there are also millions of people who have been investing for years and they still have an uneasy sense that they don't have a compass. There is so much information out there, but oddly, looking to Wall Street provides no answers.
What’s traditionally been drummed into your head is that investing is very complicated and should only be attempted by professionals or with the aid of very expensive and risky strategies and software programs. Don’t buy it. Investing doesn't need to be complicated.
The portfolio selection method, as we will call it, provides investing with structure. It enables average investors to implement the method step-by-step. The know-how of a Wall Street analyst isn't needed to understand it or use it successfully, nor is the ability to analyze and select individual stocks.
If it’s so easy, then why haven’t you heard of it before?
Wherever money is involved, there are people who want a share—and on Wall Street, it is your money they want to share. Simply put, it is extremely difficult to find someone from a large, mainstream investment firm that will level with you on your best investment options. They need to sell you expensive products that make their firm money because they are employees and that’s their job. So, what you really need to learn is what Wall Street doesn't want You to know, which also happens to be the title of a very good book by Larry Swedroe.
Here are the five investing essentials necessary to successfully use the portfolio investment method:
1. Define your goals, set targets, and decide on an asset allocation that fits your needs. Asset Allocation is simply the percentages of your money you plan to place (allocate) into stocks, bonds and cash. It determines most of your investing risk.
2. Diversify your holdings. Diversifying means placing some money in different kinds of investments in order to spread your risk.
3. Keep costs as low as possible. Whatever you spend on buying and maintaining your investments comes directly out of the returns you receive.
4. Rebalance your portfolio when necessary. Rebalancing is simply readjusting your allocation percentages back to where you originally set them so you can maintain your chosen exposure to risk.
5. Formalize your investment plan. Developing a plan and then writing it down is a way of demonstrating your commitment. It also serves as a compass to insure you stay on course.
The following chapters will explain what the essentials are and how they work with each other to create a portfolio with maximum benefit.
For those who like the technical stuff, here are two links offering an excellent introduction to the portfolio selection method.1
Note 1. Harry Markowitz, "Portfolio Selection," 1952