Rules Based investing

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The two challenges faced by most investors are greed and fear. When stock markets rocket upward, investors often feel they're missing out. So they buy in at the wrong time. Conversely, if the stock market plummets, investors sell, afraid of losing everything. 

Possibly due to the three market collapses in the past 20 years, many investors, out of fear, have not participated fully in our current 12 year bull market. Rules Based Investing, we believe, helps to overcome that problem. Warren Buffet once said there are two rules in investing. Rule #1 is "never lose money." Rule #2 is "never forget rule #1." There is a difference between attempting to time the market and using strategies to attempt to reduce risk. No person or computer can buy at the exact low and sell at the exact high.

The purpose of "rules," along with incorporating "sentiment" indicators, is to attempt to reduce the risk of large losses in order to avoid turning one's retirement plan upside down. While most of us can absorb a 10% loss, losing 40% or 50% would be devastating, especially if one is using one's funds for income in retirement If one loses 50%, one has to make 100% on the remaining capital just to get back to even. If one is taking regular income during a large market downturn, it becomes almost impossible to get back to the original principle. 

One type of a rule is to regularly check a variety of "trend-lines" showing the general direction of the market (see graph below). Stock allocations are maintained when the index/fund (blue jagged line) remains above trend on a check date (green triangles). When the index/fund falls below the trendline (red line) on a check date, then a reduction of risk is made (red diamonds). It's not always the right decision, but that's okay. It only has to be right once in a while (see late 2007) for it to make sense. 

A question for all investors to ask, whether one uses an outside professional or one manages one's own funds, is whether there is a specific process used to determine when, what, and how much of any particular investment to own. Click here to see the 4 questions one should ask one's advisor or oneself regarding investing.