The Importance of Investing Principles

Markets go up and go down. It doesn’t matter what assets we’re investing in – stocks, bonds, real estate, gold, currencies, fine art, or exotic automobiles. There are times when the market will boom and times when it will bust.

In a booming market, it can be relatively easy to invest and make money without being an expert in the asset or investing strategies. However, its when markets take a nose-dive, or even just shake up a bit, that can wreak havoc on investors who are not knowledgeable and disciplined.

But the truth is that there are risks in both up and down markets.

For this reason, truly committed investors who are in it for the duration do not just fly by the seat of their pants. They don’t just follow the latest trends or anxiously jump on whatever bandwagon the “gurus” are touting each week.

Rather, those who are successful over the long term have an established set of principles by which they make investing decisions. They develop and follow solid investing principles.

Now this article is not to prescribe what your investing principles should be. That’s another article, or probably a series of articles. Instead, this is to emphasize the importance of having investment principles in place.

Principles are a set of rules or standards that govern and guide our decisions and actions. They are derived from several sources, including personal values, our own knowledge and experiences, and the knowledge and experiences of others.

We all have certain principles that we follow in the various aspects of life, whether we have clearly defined them as such or not.

As investors, it is important to have clear principles that guide our decisions about what, how, and why we invest as we do. Principles that serve as fundamental standards against which to measure our thoughts and decisions about an investment, both in good times and bad.

For example, one of Warren Buffett’s famous guiding principles has been to never invest in a business you don’t understand. Whether you’re an expert investor or not, this obviously makes a lot of sense. How can you develop a confident strategy for how to profit from a business if you don’t understand the fundamentals of how the business operates?

An example of a sound real estate investing principle is, when taking on debt, always secure a long-term loan with an LTV of 80% or lower. That is, get a loan with a considerably longer term period than your planned exit date, and with a Loan-to-Value Ratio such that you could at least break even if the property’s value, or the entire market, were to decline by 20%. Overlooking this principle was a major factor that led to the downfall of many real estate investors during the 2008 financial crisis.

Investors should have clear principles governing all phases of the investing cycle. That is, principles for buying into an investment, managing the investment, and exiting the investment.

I’ve seen a lot written on investment principles for when and how to buy or enter an investment. Of course, this is understandable, as so much of an investment’s success truly can be attributed to the conditions under which it is acquired. The old saying, “you make your money when you buy…” has a lot of proven merit.

However, if history has taught us anything, it is that we should also follow clear principles for how we manage our investments during the holding period, and of paramount importance, when and how we exit. Even with a savvy investment buy-in, poor management and a hasty exit can completely negate the gains that should have been realized.

Unfortunately, the archives of investing of are filled with stories of those who lost so much because they panicked in a downturn and sold off at the bottom of the market.

For these reasons, its important as investors to have sound principles guiding how we buy, how we manage, and how we exit.

Finally, while our investing principles should be steady and unwavering, its also important to remember that we should always be learning from our successes, setbacks, and failures, as well as those of others.

In doing so, we should evaluate our investing principles as we learn and grow, carefully considering when changes should made to better guide our investing success.

A person who grasps principles can select his own methods. The one who tries methods, ignoring principles, is surely to have trouble. - Ralph Waldo Emerson