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Financial Tip
Rich Best has spent 28 years in the financial services industry, as an advisor, a managing partner, directors of training and marketing, and now as a consultant to the industry. Rich has written extensively on a broad range of personal finance topics and is published on several top financial sites. Recent books include The American Family Survival Bible and Annuity Facts Revealed: What You MUST Know Before You Invest.

The 3 Key Principles of Sound Investing

The 3 Key Principles of Sound Investing

Over time, highly successful investors, such as Warren Buffet, Benjamin Graham, and Peter Lynch, have distilled the secret to successful investing down to three guiding principles, which, if followed strictly, can lead to fewer mistakes and better performance over the long-term.

Principle #1: Faith in the Future

Unquestionably, these are difficult and uncertain times, and there is every reason to feel things are rigged against us.  But, history gives us every reason to have faith in the future.  The stock market has increased in value more than 100-fold since World War II.This in spite of multiple recessions, increasing global strife, massive debt and deficits, and a financial meltdown that nearly crippled the world's financial system.  In that time there have been as many bear markets as bull markets, but the duration of bear markets has been far shorter. The average duration of a bull market has been 32 months while the average duration of a bear market has been just 11 months.  And, on average, the percentage  of market decline in  bear markets (-27 percent) has been just a fraction of the market gains during bull markets (+119 percent).

What that means is the advances made during bull markets are permanent, while losses during bear markets are only temporary. With each bull market the losses of the preceeding bear market decline were made up and the gains of the prior bull market were extended. To sit out the market, even temporarily, almost guarantees you will lock in your losses and miss the eventual opportunities for gains.

Successful investors view the future optimisitically, because, to do otherwise would be to  ignore the historical record. They, therefore, stay invested.

Principle #2: Patience

The behavioral instinct of humans is to "do something" in reaction to extreme events.  When investors shift their focus away from their long-term objectives to short-term performance, the results are almost always negative. This can best be illustrated when investors bail out en masse from a declining equity market with the intention of getting back in when it turns around. That's a feat very few investors can actually achieve, leading Warren Buffet to quip, "the stock market is a highly efficient mechanism for the transfer of wealth from the impatient to the patient."

Patient investors stay focused on avoiding mistakes, and are willing to withstand the discomfort of big market swings in order to minimize the mistakes that many investors make.

Principle #3: Discipline

The final principle, Discipline, is, for most investors, the most challenging to follow. Whereas patience represents the presence of mind to avoid doing the wrong thing at the wrong time, discipline is the exercise of the mind to do the right thing by staying the course. The ability to exercise self-discipline in the face of challenging circumstances doesn't come naturally for most investors. But those who are able to do so are better able to inoculate themselves from the emotional tirades of the media and the herd.

To exercise discipline means accepting the fact that it takes risk to produce returns over the long term; and, by ignoring the events of the day, disciplined investors know that, the longer they adhere to their strategy, the more opportunity they'll have to generate positive returns.

Summary

One of the most successful investors of all time, Ben Graham, once said, "The investor's chief problem - even his worst enemy - is likely to be himself."  At its core, a behavioral framework for successful long-term investing needs to ignore the short-term consequences of long-term investment decisions, because they simply don't matter. A principled investment philosophy guided by Faith in the Future and Patience and Discipline provides the foundation for long-term success.


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