Investing can be complicated but it doesn’t need to be. If you are new to investing or you would like to consider another approach besides following the herd look no further than the Contrarian’s Investing Made Simple guide. This guide is designed to be a simple, rules-based guide to help you grow your financial knowledge and wealth.
Spend Less Than What You Earn
Common sense yes but many fail this basic rule. Don’t worry about investing if you actively spend more than what you earn. Saving is the first start to investing. If you can’t save then you can’t invest. Fix your spending or your income first.
Understand the Risks
Risk isn’t bad per se. However, risk that is not compensated for are indeed bad and should be avoided. But you first need to be able to know what the risks are.
Have you ever read a prospectus? If not you should. You might be surprised on the information in there. I’ll admit they can be a tough read but skip to the investment risks section if you are having a hard time. Prospectuses are required by the Security and Exchange Commission to list out the various risks involved.
I found many bad investments by reading their prospectus. I remember finding real estate investments that claimed to be backed by real estate actually unsecured debt (thus not asset backed at all). Similarly, I found loans claiming to be secured by a specific asset not actually secured by the specific asset but whatever asset the company wanted to pledge in the event of default.
Blindly investing without knowing the risks involved is a fool’s game you don’t need to play.
Only Invest in What You Understand
Only invest in what you know or what you are willing to research and learn about. This goes hand in hand with understanding the risks. You don’t need to be an expert but you should have a general knowledge of an investment type in order to assess risk.
If you are selecting individual stock then you should be able to have an understanding of the company and be able to read and interpret financial data. If you are looking at ETFs then you should be able to read the prospectus and understand the fund and its objectives.
Don’t understand how interest rates impact REITs? Either education yourself or don’t invest in REITs. Are you not sure how blockchain technology works? Then you shouldn’t consider cryptocurrencies (you shouldn’t anyways since cryptocurrencies are stupid).
Only Invest in Assets that Pay You
Investments that do not pay interest or dividends have little worth. Making valuation assumptions based on predicted capital gains is a waste of time since capital gains itself is derived from predicted, future dividends. Additionally, capital gains (or losses) occur when an investment is sold. I would not expect it to be common for an investor to predict when, in the future, he/she plans on selling a particular asset.
Don’t Chase Gains
Chasing gains is probably the singlehanded more repeated and common mistake people do. I’ll admit it is very hard not to chase gains. There appears to be some type of inherent human quality that attracts us to invest in popular companies or strategies.
I remember when cryptocurrency valuations were on a tear. Everyone was talking about bitcoin and alt coins and many where investing in them. I also felt tempted to buy some alt coins from all the hype. In fact, it was the feeling of wanting to participate in an investment I knew did not make sense fundamentally that led me to believe I would be chasing gains. This helped me steer clear of a bad investment.
We see the same thing play out from every historic stock bull run. The higher the stock valuations go, the more news it makes, and the more investors enter the trade due to fear of losing out. It always end in a crash.
I often look at the recent performance of an asset to get an idea on where I think the valuation could go. Most investors look at positive performance as a good thing that will continue even though we all know the phrase “past performance in not indicative of future results.” I view recent positive performance as a potential negative. If a stock or fund increased 20% over the last year, what is the likelihood this trend will continue considering we know that yesterday’s leaders tend to be tomorrow’s laggards.
Don’t overpay for assets, ever. This can be applied to any investment class or type. We are good at shopping for the best deal online but when it comes to investments we often overpay because we either don’t know what the fair value is or we don’t care. If you don’t know what fair value is then either research it or forget about it.
Real estate values can be a bit tricky to value but not impossible. More information than ever now exists online about real estate pricing. Gold pricing is straightforward as well. Stock valuation can be assessed by the price to earnings ratio and bond valuations are simple. There is no excuse to overpay for anything nowadays.
Don’t Pay to Invest
Investing in its most simplistic form is to forgo consumption with the expectation of a return in the future. It makes no sense to pay for the privilege of forgoing consumption. Avoid any investment prospects that require some type of fee for investing.
ETFs and mutual fund investments typically come at a cost (although there have been recent zero cost funds launched recently). Always shop around for the lowest expense ratio for the fund you are desiring. Avoid any expense ratios over 0.5% as the costs almost never justify the returns and competition nowadays is plentiful.
Additionally, as a general rule, avoid active management. Active management is where financial “experts” charge fees for their expertise in managing a particular fund or portfolio. History has proven time and again that active management does not outperform the general market. Not only does it cost more but the returns are historically less that passive investments.
Limit Duration to No More than 10 Years
Duration, or in other words the timeframe of an investment, should be kept to no longer than 10 years. Any more duration than provides unnecessary interest rate risk that is generally not compensated for. In times of low interest rates one may consider limiting the duration to 5 years.
Diversify Beyond Stocks and Bonds
This is pretty much self-explanatory but make sure your investment portfolio is well diversified. Owning only stocks and bonds is not diversified enough. Consider international assets and alternative assets that are tangible in nature.