FOOL'S EYE VIEW
The Basic Rules Of Investment

By James Carlisle
December 11, 2002

People get themselves into a lather about investment. There's PEs, DCFs, Value, Growth, Charts and all sorts. There are few subjects that can have occupied more column inches than what we should do with our hard earned cash. Over the years I've added a few myself, but that's about to end, since apart from the market news on Friday, this will be my last Foolish article. For once, I'll try to stick to the point.

The basic rules

The truth about investing is that it can be very simple if you just stick to some basic rules.

1. If you need money for spending in the next few years, then you can't risk it, so leave it in the bank. Where you can spare the money for the long-term, then you need to take some risks with it. Because there's a reluctance to take risk, the returns available are a little higher than with the safer stuff. In short, your long-term investments should be in the stock market (or maybe property, but let's not get into that).

2. When you take risks, then you need to do your best to control them. That means investing over a long period of time, preferably adding dollops of fresh money as you go along. You should also invest in a wide basket of shares. The widest basket of shares in a particular stock market, will be a market-weighted index tracker.

3. Every penny you pay in costs is a penny that comes off your returns. So, every time you do something, then it has to do a little better than average to make up for the cost of doing it. The more you do things (or the more you pay for someone else to do things), the more you have to be better than average to make up for the extra cost. It's a case of diminishing returns. The harder you try, and the more you move things about, the bigger the obstacles to overcome. The less hard you try, the smaller the obstacles become.

Following the rules

There are basically three different ways to stay true to these rules with your long-term investments.

(a) Keep ploughing money into an index tracker. You'll be exposed to a broad spread of shares over the long-term, with regular injections of new money and low costs.

(b) Keep ploughing money into a selection of big and cheap general investment trusts over the years. You'll be exposed to a broad spread of shares over the long-term, with regular injections of new money and low costs. (Remember to research investment trusts just as you would any normal company, since that's just what they are.)

(c) Keep ploughing money into a diversified portfolio of shares, and keep hold of them! You'll be exposed to a broad spread of shares over the long-term, with regular injections of new money and low costs.

Can you spot the common theme?!?

Not following the rules

There are three sure ways to make a complete mess of your long-term investments.

(x) Being too scared of shares. Your long-term savings will sit forever in the building society, barely keeping up with inflation.

(y) Being too heavily exposed to one or two shares or sectors. Sooner or later you'll be in the wrong thing at the wrong time and it will send your investing all the way back to the beginning.

(z) Doing too much trading. It will just increase your costs and that will reduce your returns.

Being a Fool

Being a Fool is all about understanding your limitations and not trying to be too clever. As Warren Buffett famously said "when 'dumb' money acknowledges its limitations, it ceases to be dumb".

Trying to be too clever with your investments just stacks the odds increasingly against you. Of course, it's human nature to have a little extra in the self-importance department and we all think that we have the Wisdom to overcome the odds. The elegant truth is, though, that the more you allow your ego to distract you from the Foolish basics, the more likely you are to come a cropper in the end.

So long, Fools, and thanks for all the fish.