I've found these ideas to be helpful over the years when managing money for my clients. I hope following these rules will increase your returns over time.
1. Expect 100 year floods to occur every 3-5 years.
After several years of upward trending stock prices, most people start to believe that they are comfortable with the level of volatility in their portfolio. This leads many people to be comfortable with being fully invested. The problem with this view is that the complete market cycle is not being taken into account. Many of these same people will have a different opinion of their appetite for risk after a 20%-30% correction. It is important to have a good understanding of the history of market cycles and the magnitude of asset price declines in bear markets. The markets are more volatile than most people think. Don't reach a conclusion about your appetite for risk based on how hungry you have been over the last 6 months. Think out several years into the future. It's fairly simple these days to run a simple simulation and see how your current holdings performed during the last bear market of 2007-2009.
2. Expect a 5% to 15% correction for no reason at all.
Always keep at least some cash around on hand in case the market gives you an unexpected buying opportunity. The market corrects for all sorts of reasons. Some of them make sense, and some of them don't. While it is good to have a game plan and have a long term outlook for your investments, don't expect to be able make sense of every small move.
3. Don't worry about the short term.
Too much time and energy is spent on trying to predict the next 2% move in stock prices. Don't worry about this. This is meaningless in the long term. Focus on the things that matter: The overall trend in the economy, employment, interest rates, earnings, sector rotation, etc.
I know we have all broken this rule from time to time. But some of us are worse than others. One common issue people discuss with me often is that they don't think their account is big enough to buy a high enough number of securities to properly diversify. While possible in some cases, most of the time this isn't really true. These days, most brokers will you allow their clients to buy less than a block (100 shares) of a given stock. 5 shares each of 10 stocks is a reasonable place to start for even the smallest investor. Index funds are also a clear choice when funds are limited. The SPY gives exposure to all 500 stocks in the S&P500 in a single, easy to trade, exchange traded fund.
5. Limit exposure to bonds
While not timeless investment advice, I wanted to include a warning about bonds here.
Interest rates are currently very low. Low interest rates are making bond investing very risky for those of you who might not want to hold your bonds to maturity. This is also a risk for those invested bond ETFs (which generally do not hold to maturity). When you buy a bond at today's prices, you are exposed to the very real risk of interest rates going up. If you hold your bonds to maturity, you may not care in the long term; but I the short run, your bonds will decline in value and will cause your net worth to decline. Even a "risk free" U.S. government bond will decline in value if interest rates rise. U.S. Government bonds are only risk free in the sense that the issuer will not default. Other than that, the market price can fluctuate just like any other investable asset. This is not a position that I am in favor of. In fact, I am currently short the bond market via futures contracts on the 10 year Treasury note. The Federal Reserve is beginning to reduce its support of the bond market and is expected to begin to raise interest rates next year. This is one of the main investing themes I am betting on right now.
Disclosure: I am short LQD, IEF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I am short 10-year note interest rate futures, LQD, IEF