Over twenty years ago when I first got my start in the financial services, I was taught about Four Cornerstones of Money Management. They are Cash, Variable Assets, Fixed Assets and Risk Handling. I understood then that every client had to have something in each of them, or at least address them in their asset allocation.
Since then, the art and science of planning and investing has not so much evolved as developed these Four Pillars of Investing. They are Theory, History, Psychology and Business.
A bit on context, just in case you have forgotten. We are just beginning to understand the bubble we were in from ’95 – 2000. It was a mania, and it was a “madness”. And it left many of you without an idea of how to regroup.
If this happens again, and it will, maybe these four Pillars will keep you stable and “safer”.
Pillar One: Theory
The relationship of return and risk are not severable. If a company’s stock goes up 900%, or triples or some such, it will just as likely go down 90% or get cut in half. Return and risk are not congruent or equal, they are parallel. When you buy a company’s stock or mutual fund, you are compensated for the exposure to risk you take. PERIOD. The most important step you can then take, if you haven’t already, is to manage the risk. How you manage the risk, well that is the $64,000 question, for later.
Pillar Two: History
In this most recent craze, the biggest madness was forgetting that we all have a tendency to go “barking mad”. Most forgot the recent time or event they went crazy, crazy enough to lose all focus. The investor who does not know the history of finance is irretrievably out of focus. It is all fear and greed, emotions, pure complications.
Pillar Three: Psychology
History shows me we have periods of greed, complacency and fear. Human nature bounces among rational, irrational and non-rational behaviors and thoughts. Millions invest in the lottery. Millions are searching for the next Cisco, Microsoft and Amazon. “The beginning of investment is respect for the Markets.” I say. Yet, most investors are grossly overconfident and, therefore, regularly make irrational buy and sell decisions.
Pillar Four: Business
You have to recast your view on investing into one of a business operation. Investors are touchingly naïve about what a mutual fund, a company’s stock, or a bond is. Leading research shows the financial literacy is low and failing. The more you know about the priorities of mutual funds and a company, the more likely it is that you will be better off tomorrow than today. You will have mastered the next Bubble and the Madness of the Market.