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The 10 Principles of Investing Safely

The following list outlines the principles of investing safely. They combine years of professional and personal experience; both as a management consultant, engineer, and individual investor. All this site's pages are related to helping you follow these guidelines.

  1. YOU must be responsible for your financial future.
  2. Always protect against losses.
  3. The only "good" investments are the ones that make you money.
  4. Always use a process to make investing decisions.
  5. Always trade using a structured set of rules.
  6. Continually measure the performance of your plan or system; there is always something that can be improved.
  7. Constantly pursue ways to reduce costs.
  8. Before you invest, you must understand personal finance, market factors, and money management techniques.
  9. Improving your results requires improving your system; tools alone will not improve your profits.
  10. Learn from your mistakes (i.e. losses); you've already paid for them.

1st Principle of Investing Safely

YOU are responsible for your financial future

YOU MUST CONTROL YOUR MONEY. No one else is, nor can they be, responsible for your financial future.

It's easy to find excuses when you give up control of your finances. And having someone or something to blame may feel good for a while.

It's my broker's / spouse's / boss's / CEO's / adviser's / neighbor's fault. Or Wall Street's / Europe's / China's / Big Bank's / Corporate America's / President's / Republican's / Democrat's fault. It's not my fault.

But tomorrow, you'll still have bills to pay, debts, and everyday expenses. And none of those other people will help you there. In other words, blame does not pay the bills.

2nd Principle of Investing Safely

Always protect against losses

Always, always, always, cut your losses. Always. Don't hold positions that are in the red, waiting for the market to turn around.

After a loss, you have less capital to invest. Less capital means you need a higher return on your investment to recover the same amount of money you just lost. See the example graphic below:

Compound Interest Example - Yearly Compounding Needed to Break Even

Time Required to "Catch-Up" after a One Year Loss of 7%
(Click the image for a deeper explanation of compound interest)

If you lose 7%, you don't just need a 7% win to balance things out. You'll need more than that.

Many financial experts talk about investing and trading as though they were zero-sum games: In order for you to buy, someone else has to sell. In order for you to make money, someone else has to lose money.

Actually, it's worse than that...trading and investing are a NEGATIVE-sum games. When you buy a stock, someone else does have to sell it to you. But that someone else isn't your neighbor. It's a broker or dealer that acts as a middleman. And neither you nor your neighbor play the game for free! Both buyer and seller use a broker, and that broker charges BOTH sides commissions and fees.

If investing were zero sum, everything you gained or lost would go to the other person. Instead, you lose part of your gain to the broker, and the other person adds to his loss!

3rd Principle of Investing Safely

The only "good" investments are the ones that make you money

All investments are bad until you sell them for a profit. Why? Because any time you have money in the market, you can lose that money. That's why they say that money in the market is "at risk"...it's at risk of losing value.

Only after you sell can you can figure out whether you made a good investment. Many investors only focus on the buying part...perhaps that's why buy and hope, I mean hold, is so popular.

But learning how to sell is just as important as learning how to buy!

4th Principle of Investing Safely

Always use a process to make investing decisions

Do you know why NASCAR, MotoGP, and other motorsports garages have bright, smooth floors? Because with a bright floor, it's very easy to see something that's out of place. Nuts, bolts, hoses, fluids, and anything else that should be ON or IN the car or bike shows up immediately.

Your investing process can do the same thing for your finances. Your personal financial statements will show you where you're leaking money. Over time, your track record will show you whether your process is working or needs refinement.

5th Principle of Investing Safely

Always trade using a structured set of rules

Following rules is a key to repeatable investing success. When you invest the same way, over and over again, you'll quickly notice when things aren't going according to plan.

If you don't follow a structured set of rules, there is no way to know whether your system works or if you're just lucky.

6th Principle of Investing Safely

Continually measure the performance of your plan or system; there is always something that can be improved

Peter Drucker, the father of management science, once said "what gets measured gets managed".

The same goes for investing. Measure the results of your investing process. How long is your money at risk? How many winning trades do you have? How many losing trades do you have? Are you always limiting losses at 7%? How long does it take before you close a trade that isn't working out? How long to you hold on to a winning trade.

Don't forget that improving a system isn't always about profit and loss. How much time do you have to spend on personal finances, investing, or trading? If you're spending every waking moment working on your investments, odds are there is room for improvement!

7th Principle of Investing Safely

Constantly pursue ways to reduce costs

Let's say you invest $50,000 in a mutual fund that charges you a 1% "fee" (which is low for a mutual fund). After a year, you check your account and see that the mutual fund gained 4%. Great!

Not so fast. The mutual fund actually gained 5%, but the fee is backed in, so you you never see it straightaway. Instead, you paid the fund owner $500.

But that is only for 1 fund, 1 year, and $50,000. What happens as your account grows to $500,000 or even $1,000,000 over a 20-30 year time frame?

And those high costs, whether they're in the form of broker fees or credit card interest rates, are just another form of losses that need to be recovered. Principle #2 is the reason the Principle #7 is so important!

Don't pay ATM fees...this is a per use loss.
Don't pay monthly maintenance fees on checking accounts...this is a monthly loss.
Don't keep balances on high interest rate credit cards...this is a monthly loss.
Don't get high interest rate loans for things that depreciate like cars...this is a monthly loss.

8th Principle of Investing Safely

Before investing, you must understand personal finance, market factors, and money management techniques

There are two situations everyone thinks about; where you are and where you want to be.

It is not enough to navel gaze about how you "wish" things were, or how you "think" things are...you need to know how things really are right now. Only then can you begin to change them.

Some say that a goal without a plan is just a dream. I say switch it up: Your financial dream is only a plan away.

You need define your starting point, or baseline, if you plan to achieve your goals. This requires you to master personal finance.

You need to learn how the stock market works, so you'll understand the rules of the game. This requires you to the master market-based factors that impact your returns.

Most importantly, you need to know how to limit risk. All investments are risky when you don't practice money management techniques.

9th Principle of Investing Safely

Improving your returns requires improving your system; tools alone will not improve your profits

Tools such as discount brokers, ETF's, hedge funds, trading platforms, etc. can all be very helpful to investing. However, a majority are set-up to keep you busy, rather than to make you money. If tools were guaranteed to make money, they'd say so.

That is why it is so important to improve your system. 20 years ago, people made money in the stock market without all the technology we have today.

How did they do it? They created a system for making decisions and then used the tools that were available.

Today's technology gives us more data, more often, more quickly. But all successful investors use a decision-making process to cut through noise and leverage all those tools into a money making opportunities.

10th Principle of Investing Safely

Learn from your mistakes (i.e. losses); you've already paid for them

Admitting mistakes is hard. Admitting mistakes that involve money is almost impossible. Why? Because no one likes making mistakes in the first place. Throw some money in the mix, and you've created one of the most emotionally charged issues that exists.

If you have a long term view of investing, you know that the journey is going to be filled with some peaks and some valleys.

Check out this video from William O'Neil, founder of Investors Business Daily. He touches on how learning from your mistakes will save you money.

Losses are unpleasant, but also let you know that something in your system didn't work. Just make sure they don't get out of hand (See Principle #2)

I'm sure one of your goals is to have a stress-free retirement (at least financially speaking - you might enjoy sky diving). Working out the kinks in your process beforehand will give you the experience and confidence you need to make that happen.