The only two things you need to know to be a successful investor

published 6 March 2015

150306-investing — Successful investing is within anyone's reach

There are two things you need to know to be a successful investor.

By successful, I'm not talking about being the next Warren Buffett. I'm talking about getting to retirement age with a pot of money that allows you to stop working while maintaining a similar standard of living.

That's an admirable goal. And it's within most people's reach. To get there, there are two things you need to know.

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One: keep your costs down.

Two: once you have a plan, stick to it.

You can stop reading right here if you're happy you've absorbed that. But if you want a bit of proof, read on.

Asset allocation matters but fees matter more

cyclically-adjusted price/earnings (Cape) ratio

John Authers picked up on a theme in Faber's latest book (Global Asset Allocation) in the FT earlier this week. Faber's book examines various famous asset allocation strategies and tested how they would have done between 1973 and 2013.

We've written a lot about asset allocation. But to sum up, the point is to avoid putting all your eggs in one basket. You stick some money in shares, some in bonds, and some in gold or property or cash or whatever. The idea is that over time, you get a smoother ride to your end financial destination without sacrificing too much in terms of returns.

Of course, opinions vary as to what the best way to allocate your money is. There's Harry Browne's famous permanent portfolio' split your portfolio equally between shares, bonds, cash and gold. Or there are more complex strategies followed by hedge funds, like Bridgewater Associates, for example.

So what did Faber find? The core point was that the gap between the best and worst-performing asset allocation strategies was less than two percentage points a year. And excluding that strategy, "all of the others were clustered within one percentage point of each other per year."

Now don't get me wrong. One percentage point can make a huge difference over time. However, as Authers points out, "fees plainly matter more than asset allocation providing that asset allocation is within the spectrum of sensible ideas".

In other words, if you'd racked up even one percentage point more of extra annual fees in implementing the most successful strategy, you'd have squandered any advantage over the worst-performing strategy.

In other words, if you're given the choice between a simple, cheap asset allocation strategy, and an expensive, sophisticated-looking one you'd be better off going with the cheap option.

Find a sensible strategy and stick to it

John Bogle, the founder of Vanguard, has probably done more than anyone else to bring passive investment strategies to small investors. And yet he's really not a fan of exchange-traded funds (ETFs). An ETF is just a listed version of the tracker funds that Vanguard specialises in. What's not to like?

Bogle's point has always been that ETFs make trading too easy. And while I'm a big fan of ETFs, I see where he's coming from. Human minds are not designed for investing.

Bill Bonner made a very good point in his daily missive the other day in most other areas of our lives, action pays off. If you want results, you have to do something'. But very often, in investing, you only need to act very rarely, once you've set up a strategy that you're happy with.

So anything that makes it easier for investors to get sucked into that world of hyperactive trading is a step in the wrong direction. So there's nothing wrong with ETFs per se it's just that they make it easier for us to shoot ourselves in the foot as investors.

You see, another finding that consistently comes up in research is that private investors tend to pick the wrong time to buy and sell. All that chopping and changing not only increases transaction costs they also have a tendency to sell low and buy high. In many cases, they would have been better off sticking with even a mediocre strategy rather than attempting to chase fashions.

I'm not saying for a moment that you shouldn't have a portion of your portfolio that you experiment with. For some of us, investing is an entertaining intellectual exercise a hobby. Stock picking can be fun. Finding fascinating new themes and considering the big macro' debates I get a real kick out of it and I'm guessing you do too.

But as far as your core portfolio goes (ie the majority of your money your retirement fund), you should have a relatively simple asset allocation strategy that suits your stage of life. Find the cheapest way to implement it. Save regularly. Rebalance when things get too out of whack. But most important of all stick to it.

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.