The science of dentistry and of investing follow similar processes. To manage your assets better, follow these 3 fundamental rules.
You plowed through some pretty tough stuff in college like human anatomy. You excelled in a rigorous academic environment and mastered dozens of subjects for your board exams. The process of learning challenging scientific concepts you mastered in college should not be abandoned when it comes to your investments.
The science of dentistry and the science of investing follow similar processes. Just like chemistry has fundamental laws that help us understand the structure, properties, and reactions of matter, the science of investing has fundamental laws that help us understand the behavior of different types of assets (businesses, property, and financial assets like stocks and bonds).
I realize there are dozens of opinions out there—family, friends, financial advisors, and the media. But opinions aren’t scientific facts, and there is an academically supported science that exists for investing. Nobel laureates, university professors, and financial professionals formulate much of what we know about this science. The science of investing is not subjective, and it’s not a series of mantras you’ve heard from parents or friends.
Most dentists have an investment portfolio that looks more like a roulette table than a periodic table of elements; their portfolios feel much more like gambling than investing. If you don’t know anything about the science of investing, it’s likely you will feel confused, uneasy, or frustrated about your investments, especially during down markets. Here are a few tips to help you learn the science of investing:
1. Don’t hold too much cash in your accounts. If your money isn’t growing, you’re losing at least 3% per year to inflation.
From 1926 – 2013 the cost of everything rose exactly 3% per year (the consumer price index). In 1913, you could buy a quart of milk for 9 cents; in 1963, that same 9 cents only bought you a small glass; and in 2013, 9 cents bought you a measly 6 tablespoons.
During your career and throughout retirement, you have to earn at least 3% to maintain your wealth. Many people are NOT averaging this return when taking all their assets into consideration. If you don’t have a plan, get one. A short-duration bond index (municipal or corporate) is a better alternative to earning nothing.
2. Don’t pick stocks or mutual funds that do the same thing. The odds are not in your favor.
If you’ve ever thought about investing money, you’ve probably heard people say:
“I have a proven system to pick winning stocks.”
“That sector will continue to go up next year.”
“The market is primed for pull back.”
All of these statements reflect someone trying to predict the future direction of the economy, the stock market, or an individual stock. Many people think this is the key to successful investing. In fact, when people meet financial advisors or other investment professionals, their first question typically is, “where do you think the market is going?”
Predicting the future is futile—especially for investors who are trying to protect their life savings. Let me suggest a better method:
At an event, participants were asked to estimate the number of jelly beans in a jar. People had widely different views and guesses ranged from 409 beans to 5,365 beans. But here’s the interesting part—the average guess was 1,653 beans and the actual bean count was 1,670. The average of all the guesses was remarkably close to the actual amount of jelly beans in the jar.
And that’s exactly what a stock or bond market does really well—it gives us an average guess of all the participants in a market. The average guess is shared publicly, and it is reflected in a stock or index price. These prices give us an average guess of all participants and can help us approximate how many beans are in the jar or how much a company is worth. So on any given day, the average guess of all participants is an extremely good estimate of the actual price we should expect to pay to own a portion of a company. In other words, today’s price (the market price) is a fair representation of value.
So, don’t pick individual stocks based on how well you think things are going to be down the road. If you try to single out winners and losers in the stock market, it’s not much different from trying to guess how many jelly beans are in a jar. Together, we know more than we do individually.
3. Don’t try to move in and out of the overall market or industry sectors.
Don’t move in and out of industry sectors based on trends you hear. Sectors are divisions of the market like gold, energy, consumer staples, technology, or industrials. You might hear people tell you that “gold” is hot or “energy” is going to have a great year. Don’t be tempted to chase these trends. A broadly diversified portfolio holds all sectors using a percentage that closely follows their size in the overall economy.
Check this chart out. At the end of last year, there was $45.4 trillion of publicly traded stock in the world. A good starting point for diversification would be to see if your portfolio contains similar exposure to stocks in various countries and markets. As you invest money each month into your portfolio, you can keep your investments similar to the way the world is evolving.
Also, don’t try to time the stock market by jumping in and out when you think conditions are good or bad. Market timing is unreliable and risky and the odds are not in your favor. It’s no different than trying to get in and out of a dental practice quickly or in and out of a home quickly. Assets change prices on a daily basis and stocks are no exception.
The price of a company changes rapidly because the public is legally required to know most everything there is to know about the company. Diversify your investments by using low-cost, broadly diversified exchange traded funds or institutional mutual funds. Get some help building a portfolio that represents the overall global market. Click here to see a global market map.
Investing in the stock market should not feel like a mere roll of the dice; if it does, then you likely have some major misconceptions about investing and may have problems in your current portfolio.
Stick around and you’ll see how investing in markets is a simple science that, when mastered, can make your life less stressful and help you enjoy the things that matter most.