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7 Principles for Investing Success

Keeping Investing Simple, With 7 Principles
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Mark Riepe, head of the Schwab Center for Financial Research, discusses seven time-tested principles that can help you along on your investing journey. 

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Janet Alvarez:

Sometimes, it’s the simple things that make the biggest difference. And in a time when we have access to more investing ideas and information than ever before, it’s essential to remember the tried and true principles that have guided investors for generations. Many of these concepts, like diversification and establishing a solid financial plan, are well known themes, while others may not be as familiar. Mark Riepe, head of the Schwab Center for Financial Research, joins us to identify and explore the seven core investment principles that are essential for investor success.

Mark Riepe:

It’s impossible to anticipate everything that’s going to happen, so it’s important to revisit your plans at least annually and then make adjustments as needed going forward.

Janet:

You’re listening to the Insights and Ideas podcast, brought to you by Charles Schwab. I’m Janet Alvarez. Whether you’re a sophisticated investor or just getting started, there’s never a bad time to look at what you’re doing and get down to basics. Mark will guide us through these investing principles, what they mean and the steps you can take to get the most from them.

Janet:

Hi, Mark.

Mark:

Hi, Janet, how are you doing?

Janet:

So Mark, today we’re focusing on the seven key principles Schwab singled out as essential to investing success. Can you talk a little bit about how these principles actually reflect the underlying investment philosophy that Schwab espouses?

Mark:

Well, our underlying philosophy, really in plain English, is that you need to identify your goals. In other words, why are you investing? What are you trying to achieve?

You then need to actually get invested. And then finally, you need to stay on track. And so that’s the philosophy at its most basic level—the foundation, if you will—and then the principles really sit on top of that foundation and serve to make the philosophy more tangible and more actionable.

Janet:

So the first principle is to establish a financial plan, but what does it mean to actually have a solid financial plan?

Mark:

So I think solid plans really have a couple of characteristics. First of all, they’re realistic. It’s easy to put a plan on paper, but what separates a solid plan from, let’s say, a flimsy plan is that solid plans are based on reality. Plans by their very nature really are about an unknown future. How are you going to get from where you really are today to your goal? And in order for that plan to be solid, it needs to be realistic as to where you stand right now.

What resources will you have at your disposal going forward—for example, your savings rate? And you’ve got to make sure your goals line up with that. Secondly, solid plans really aren’t chiseled in stone. That seems a little bit like a contradiction, but good plans have flexibility built into them. I’m sitting right now here in San Francisco, and the buildings around me, they’re all built to withstand earthquakes. But the solidness of their construction really comes from them not being rigid and brittle but having flexibility built in so they can sway when turbulence hits.

And financial plans really are no different. It’s impossible to anticipate everything that’s going to happen, so it’s important to revisit your plans at least annually and then make adjustments as needed going forward.

Janet:

The second principle is to begin saving and investing today. Why is a dollar saved or invested today really much more valuable than one saved or invested tomorrow?

Mark:

That’s a good question. I think it comes down to the fact that when you’re investing, that’s really inherently an act of optimism. By that I mean you’re taking your hard-earned money, you’re buying a piece of a company or you’re loaning it to someone else who’s doing something productive with it. And then you, the investor, is going to benefit from that if the company is successful or if the borrower is able to make interest payments to you and repay the loan.

But the thing you’ve got to remember is that growth takes time, and a failure to invest today means that you’re missing out on growth opportunities that you could have been earning instead of just leaving your money sitting on the sideline.

One common hurdle, probably the one I see the most often, is it’s really just a lack of confidence. To get over that, you simply need to get educated about the basics of investing. And really, more knowledge leads to more confidence. Another way of dealing with lack of confidence is to start small.

If you have, I don’t know, let’s say $50,000 to invest, you don’t need to invest all of it right away. Take a small portion of that—I don’t know, let’s say $5,000—put that to work and get going with that, and then build on that over time as you gain experience. Another hurdle is a very human one, which is procrastination. That’s really a tough one to deal with, but I think it helps to ask yourself: How important is your financial future?

If it’s very important to you, then the next question is: What am I doing right now to secure my financial future? If the answer is “Not much,” then there’s a mismatch between what you say matters to you and your actions, and you really need to bring those two into alignment.

Janet:

Building a diversified portfolio is the third principle. What are some good ways that you’d recommend to test whether a portfolio is well diversified?

Mark:

Well, the simplest way, and you don’t have to be super mathematical to do it, is to just look at the movements in prices of things you own. If everything you own is going up and down together, then you’re probably not diversified. You can start doing this right now on a going-forward basis, or you can just go back in time—if you’ve saved your statements—and look at past periods when prices were volatile or markets were volatile and see how the different components of your portfolio have performed.

Janet:

What are some of the most common psychological pitfalls you that see that keep investors from actually succeeding at diversifying appropriately?

Mark:

Two things seem to come up again and again. First, people confuse the number of things they own and assume that that’s a good proxy for diversification. In other words, too many people think that if I own, let’s say, five mutual funds, I must be well diversified. And that’s not necessarily the case. If those mutual funds are all investing in the same things, or if those mutual funds are really focused on too narrow of a slice of the market, then you’re not diversified.

And a related pitfall is that people know what they own, but they don’t really understand why they own it. They don’t understand, as we were talking about before, the conditions under which these things will be doing well and doing poorly. So you’ve got to really get that good understanding as to what’s really driving the components of your portfolio.

Janet:

So Schwab’s fourth essential principle is minimizing fees and taxes. What are some of the most common areas that you’ve seen where investors tend to be overpaying fees without knowing it?

Mark:

I think most people understand that when you buy a mutual fund or you buy an exchange-traded fund, an ETF, that there’s a management fee associated with owning each one of those. But what they don’t understand, I don’t think, as well as they should is the magnitude of the management fee and how different those fees are from fund to fund.

Another fee that doesn’t get a lot of attention is when you buy or sell an individual bond. Prices for the same bond can really vary from broker to broker. Some firms charge a flat fee to trade a bond. Others charge a percentage of your overall trade value. So it really pays to shop around in those areas.

Janet:

What other important questions should people ask when they seek to minimize costs in their portfolio?

Mark:

Well, I think the first thing to do is take a look at your statement and really scrutinize that statement and make sure you’re understanding every charge that’s on the statement. You should know what those charges are. You really need to know what you’re paying for. If you don’t like the charges, then you should be talking to your broker about whether there are ways to reduce those costs. And if you don’t like the answers you’re getting, then of course you can always shop around.

Now, when you look at a statement, you’re not going to see some of the more embedded fees, like management fees on mutual funds and ETFs. Those aren’t going to be broken out in the statement. But if you’re working with an advisor, then ask the advisor how much the fees are. And ask them if there’s a cheaper alternative—for example, a different share class of a mutual fund.

Janet:

The fifth principle today is about building protections against losses by holding different asset classes, such as bonds or cash reserves. Can you talk to us a little bit about how these asset classes work in a diversified portfolio?

Mark:

Yeah, that’s exactly right. Over the long term, stocks have the best potential for higher returns. But you pay a price for that because those returns come with a lot of volatility over the short term. And so if you think back to, for example, during 2008 and early 2009, you can see all the volatility that you can get with an equity-heavy portfolio. And when you take a tumble thanks to a big market drop, frankly, it can take many years for a portfolio to recover from that.

Now, if you’re a long-term investor who’s thinking in terms of decades, then that’s not really a big deal. But if you have a short-term horizon, then you may not have the time to really wait and earn that back. And so things like bonds and cash, because they’re driven more by interest rates and other factors, and they’re just inherently a less-volatile instrument, that’s going to help smooth the ride over the short term compared to an all-equity portfolio.

Janet:

The concept of rebalancing your portfolio regularly is the sixth principle. Why is rebalancing important?

Mark:

Yeah. So I mentioned at the beginning of our conversation here that a key component of an investing plan is that the investments needed, they’ve really got to match up with the amount of risk that you’re willing to take on.

And rebalancing is really just a mechanism to make sure the level of risk in the portfolio remains roughly constant over time.

Janet:

Making a financial plan is essential. And rebalancing is the key to keeping your plan on track. If you have a diversified portfolio, the holdings in it won’t go up and down in lockstep. Over time, your investments in certain asset classes or sectors will grow, while others will stay the same, or even decline. That can lead your asset allocation to depart from the one you originally decided would be appropriate for your goals. This is where regular rebalancing can play an important role. By examining your current portfolio against your initial investment plan and your ultimate goals, you can make the appropriate purchases and sales to bring your portfolio back in line with your long-term plan.

Janet:

So Mark, how often should investors rebalance their portfolios?

Mark:

I think, Janet, it’s less about the frequency and more about the magnitude. And by that I mean we’ve got some portfolios that we manage here, and what we do, really, is we examine those portfolios on a daily basis.

And if the deviations of the different asset classes and things we own in the portfolio are really large, then we go ahead and trim the positions that have grown too large—and then use the proceeds to buy more positions that have become too small. And so it’s something that we’re looking at on a regular basis, but we’re only really acting upon it if we see big deviations from where our target allocation is.

Obviously, I think for most individuals checking something daily, that’s probably overkill. So it’s something that people, I think, should pay attention to probably monthly or quarterly, but only take action if things really have gotten out of whack.

Janet:

So our final principle, Mark, is to ignore the noise. But how do we know when to actually act on information, then? What warning signs should we look to in order to distinguish good information from the noise we should ignore?

Mark:

So, that’s surprisingly difficult because let’s face it: A lot of the noise that’s being generated is by perfectly reasonable people who are really trying to make short-term predictions about what will happen to the market. And reasonable people can have very different opinions about what’s going to happen in the future. That’s why we have markets. That’s why prices fluctuate: We’ve got a lot of different people with different perceptions as to what’s going to happen in the future.

So I think my advice is really for people to take a look at the news flow and then ask yourself: “What events really have a chance of making a big difference to the odds that my portfolio is going to be staying on track and help me achieve my investing goal?” I think when you start looking at things through that lens, a lot of that news just becomes not all that important for someone if they’ve got a well-diversified portfolio, or any one particular holding is not going to be highly influential in their performance, and for someone who’s got a longer-term horizon.

Janet:

Keeping all these principles in mind, what can listeners do to start implementing these steps? What’s the next step?

Mark:

Well, what I would do is, when this podcast is done, just ask yourself: What are the most important things down the road that you want to accomplish that actually require money? Don’t make a long list. Just think of, say, the top three priorities. And once you’ve identified those three things, make a list of things that you’re actually doing right now to make them happen.

Janet:

Thank you very much for speaking with us today.

Mark:

Sure. Glad to.

Janet:

Mark Riepe is head of the Schwab Center for Financial Research. You can follow his insights on Twitter @SchwabResearch and learn more about Schwab’s seven core investing principles at Schwab.com/principles.

That’s it for this installment. The Insights & Ideas podcast is brought to you by Charles Schwab. You can find us on iTunes or at insights.schwab.com. If you enjoyed this episode, please subscribe and write a review on iTunes. Thank you for listening.

Important disclosures:

Investors should carefully consider information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by visiting Schwab.com or calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.

Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Unlike mutual funds, shares of ETFs are not individually redeemable directly with the ETF. Shares are bought and sold at market price, which may be higher or lower than the net asset value.

Investing involves risks including loss of principal.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may increase your tax liability. Rebalancing a portfolio cannot ensure a profit or protect against a loss in any given market environment.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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