This is the fourth in a series of Money and Markets columns where I’ll share with you the five essential building blocks that can help you successfully earn enduring investment gains in your portfolio.
The first building block that you must have to grow your nest egg is a Better Investment Model. As you’ll recall this means kicking the concept of luck to the curb and fine-tuning your process so you can confidently apply it to any future investments you make.
With a time-tested model in hand that you can trust and easily implement, you are well-on-your-way to the second building block: Finding Superior Information amid a slew of TV reports, newspapers, and thousands of Web sites that provide little or no investment value.
Today I’ll follow last week’s discussion, Controlling Risk, where I used Ted Williams’ approach to hitting a baseball to explain the concept of selectivity — with another baseball analogy to introduce the fourth element required for investment success.
Balance and Diversification
Along with selectivity, another way to protect your capital is to properly balance and diversify your investments. Proper balance and diversification will enhance your returns and limit the amount you can lose on any one trade.
|By consistently going for singles rather than homeruns, you’ll boost your chances of winning the investment game.|
Think of properly balanced and diversified trades as the equivalent of hitting singles in baseball. The goal is to stay in the game and get on base, not hit homeruns every time you come to the plate. Successful investors recognize that significant returns can be earned if they just keep cranking out single after single after single.
While it may be obvious, the first rule of making money is: Don’t lose it. Unfortunately that’s not always possible since, as experienced investors know, losses are an inevitable part of investing. However, it is vital to control your losses and limit their size so you can protect your investment capital.
One way you can do this is to invest with purpose. By that I mean understand why each investment is in your portfolio and how it can help your nest egg grow. Equally important, is to know why you’ve excluded others.
Avoid the Wipeout
The greatest risk to your investment capital is the wipeout — losing all or most of your nest egg. And it is caused by two very bad mistakes made by lots of inexperienced investors …
The first is the “sure thing” trap, where investors find market opportunities they think are “sure things.” Then, because they are convinced it is a sure thing, they exponentially increase the amount of their portfolio they put at risk.
The second mistake is investing in complex and hyper-active trading strategies because they appear to promise extraordinary profits, even though the odds are stacked highly against them.
In both instances, these investors are trying to hit grand slams every time they step up to the plate. They grip the bat hard, grit their teeth, and swing away without discipline. They haven’t adopted a singles-hitter mentality. They don’t know that the investor who is always trying to hit the ball out of the park strikes out the most. And as a result pretty soon they are out of money.
Successful investors know that wipeouts are a financial disaster. They understand the cruelty of the arithmetic associated with big losses and know if they suffer a 50 percent loss, they have to earn 100 percent just to break even!
Yes, savvy investors know, if you lose half your investment capital, it takes an all-star effort just to get back to where you started. That’s why you should use balance and diversification and stay focused on cranking-out the singles to grow your portfolio.
An Example of Using Balance and
Diversification to Crank Out the Singles
As an example of an investment that uses balance and diversification to earn superior investment returns, consider the Sit Dividend Growth Fund (SDVGX).
SDVGX owns only 90 of the highest quality companies located primarily in the U.S., but most have operations throughout the world. By selectively investing in high-quality, well-established businesses with durable long-term growth prospects and growing dividends, SDVGX logged a return of more than 16 percent over the past year.
The fund currently carries the coveted five-star Morningstar rating and has outperformed its benchmark — the S&P 500 Index — over the most recent one, three, and five-year time periods.
Stay tuned. Next week I’ll bring you my final building block for investment success and explain how staying the course will get you to your goal.
P.S. If you’d like to follow along with me as I issue “buy” and “sell” signals while using the essential building blocks I have been discussing in my Money and Markets issues, click here to find out more about my Park Avenue Society trading service.