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Business // Thinking Smart
David S. Chang

Principles Of Long-term Investing

Increasing your wealth over time is more than picking the right stock or always buying low and selling high.

Too often we see intelligent investors shoot themselves in the foot by making basic errors in their investing strategy. Through years of experience, I have observed the effects of fear, greed, lack of discipline, groupthink, and many other pitfalls that investors experience.

For this article series, I have compiled a list of eight principles of long-term investing that you may find useful in helping you make investment decisions.

1) Focus On Total Return. To maximize investment growth over time, it’s critical to factor in the effects of fees, taxes and inflation. Many posted investment returns exclude the fees, which come right off the top of each year’s gains. Dig deeper to find out how much that performance is costing you each year. Taxes take a serious bite out of your investment gains, and it’s important to structure your investments to account for taxes on capital gains, dividends and income.

Taxes shouldn’t be the primary driver of your investment strategy, but incorporating tax efficiency into your overall plan will help you keep more of what you earn. Inflation also can eat away at investment growth each year. If inflation is at 4 percent, a $100,000 portfolio invested today will be worth only $67,500 in 10 years!

An investment strategy that fails to account for the effects of fees, taxes and inflation severely will handicap your ability to increase your wealth over time.

2) Invest For Longevity. In an effort to reduce risk, many people over-invest in fixed-income securities, which are highly exposed to inflation risk since they do not have the same potential for capital appreciation as equities. Your portfolios should contain enough exposure to equities for their ability to fight inflation through growth.

Historically, common stocks have offered the best performance over time. Since 1926, U.S. stocks returned an average of 10 percent annually, while U.S. bonds returned just 5.5 percent, and inflation during the same period was 3.2 percent. It can be difficult psychologically to weather the volatility of the stock market, but investors who fail to adequately plan for inflation risk running out of money later in life.

3) Avoid Chasing The Crowd. No one knows with certainty the direction markets will go. A good proverb to remember is that it is usually wise to avoid following the herd. By the time your friends, family, neighbors and newspaper columnists all are investing in a particular sector or security, it’s often too late to benefit because the hype already has inflated the price. By the time the mass of average investors has caught on to a new fad, prices often are too high and investments are over-valued, making them a poor choice for investors who are seeking value. Investment clubs, popular during the 1990s, were examined as part of a study about the dangers of groupthink. Researchers found that portfolio returns of investment clubs lagged the S&P 500 index by 3.7 percent per year, meaning that members did worse as part of the group than the market overall during the same period.

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