The Prudent Investor Blog

3 Simple Truths to Become a Prudent Investor

Posted by Benjamin Coakley on Thu, Dec 06, 2012 @ 01:08 PM

prudent investorSuccess in investing is not as complicated as some people make it out to be.  It doesn't require a crystal ball or a bunch of numbers and charts.  However, if you do research on any investment, this is typically what you see.  Type any investment in and you will see what I am referencing.  All of this is designed to make you think that investing is a complex discipline. 

Becoming a prudent investor requires you to understand that this visual noise is designed to make you think that it is impossible to understand investing.  However, there are some simple truths to investing that you do not need to be an expert to understand.  Understanding these truths can allow you to begin to make tremendous progress in your investment portfolio.  This is critical now in our society because the number one issue facing our society is lack of retirement savings.

The simple truths that you must understand to become a prudent investor are as follows:

  1. No one can accurately forecast the economy or any financial market: this is the biggest thing that keeps investors from reaching their retirement goals or underperformance in their portfolios.  There are many companies that spend millions of dollars trying to convince you they have the people with the crystal ball.  Do not fall into the trap of believing this is possible because all the academic research points to it being untrue.
  2. Diversification is the key to long term success: every investor has heard the term diversification.  Understanding how asset classes interact with other asset classes can help increase expected returns and manage risk.  This is the main premise of Modern Portfolio Theory.
  3. The Little Things Matter: The issue of fees in your investment portfolio has been discussed over and over again in the last couple of years.  We hear this when we are talking with people and believe that this is a good thing.  However, when we ask people how paying higher fees affect a portfolio, they typically do not understand the actual impact of this (in actual dollars).  And the amazing thing is, the fees don't have to be extremely higher to have tremendous impact on a portfolio.  The chart below shows the impact of .48% higher fees on a porfolio of $100,000 over 20 years with a 6% compound growth rate. The ending value of the DFA fund with lower fees is $214,363.49 while the ending value of the Fidelity fund is $185,019.28.  This is about a $30,000 difference.Expenses and the Prudent Investor

Remember that prudent investors typically end up with more money because they understand the three truths above.  The next time you think about your portfolio, use the above truths and test them against the advice you are getting.  You may be suprised at the results.

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