The 80:20 Rule of Investing, Episode #5

You may have heard of the Pareto principle, which is the observation that 80% of the outcome often comes from 20% of the effort that goes into it. It’s our goal to help people nail those 20% activities, the things that truly move the needle with their investments. That’s why we encourage everyone to focus on the handful of essentials in investing that truly make a difference.

This episode highlights five key principles that lead to investing success. In many ways, this approach is similar to the process of losing weight and getting in shape. There are simple, sometimes obvious, things that lead to the desired results, but they can often be difficult to execute and stay consistent with. Investing is much the same.

Outline of this episode

Principle 1: Get a plan in place [2:01]
Principle 2: Focus on what matters [4:30]
Principle 3: Diversify your investments [7:30]
Principle 4: Control costs [10:40]
Principle 5: Manage your own behavior [14:44]

Principle 1 – Start out with a plan aimed at your goals

It’s vital to have a plan because your plan is what will help you stay on track, make smart financial decisions, and assess what’s happening when the market is acting up. It will also help you know how to invest in light of your particular goals.

For example, if your goals are aimed at funding your retirement, which is a long-term goal, you’ll invest differently than you would if your goal was to fund your child’s college education, which is a closer goal.

A good plan helps you tune out the noise and stay focused on your goals — and stay calm if the market is trending downward. Don’t focus on beating an arbitrary benchmark, focus on hitting your particular goals. You can do that by creating a clear plan for your investing.

Principle 3 – Diversification

You’ve heard the old saying, “Don’t put all of your eggs in one basket.” When it comes to investment strategies, that’s a great thing to keep in mind. It’s what we refer to as diversification. You don’t want to invest in only a handful of stocks, you want to own thousands of stocks in your portfolio, spread across the entire world. The reason is simple. It’s possible for a few individual companies to tank, but it’s almost impossible for every company in a truly diversified portfolio to do so. Diversification helps you to have a smoother investing journey over time, and can also improve your investment returns.

ETFs and mutual funds provide easy diversification, so it’s not uncommon for a portfolio made up of a handful of these investment holdings to adequately spread your investment dollars over thousands of companies. You won’t invest enough of any one stock to make a killing on it, but you also won’t own so much as to be killed if it goes the wrong direction.

Principle 5 – Manage your own behavior

Human beings are naturally wired to be poor investors. Why? Because we make emotional, irrational decisions, when investing requires a logical, calculated approach. Investors too often swing between states of greed and fear, which doesn’t serve them or their portfolios very well. Studies have shown that if the average investor did nothing with their stock portfolio over time, they’d do much better than they do through the hunch-based buying and selling that’s typical of most.

This principle is important to understand because trying to time the market is nearly impossible to do on a consistent basis. Some will point to aberrations as proof that they have learned some secret formula to timing the market, but don’t confuse luck with skill. Things that sound too good to be true usually are. Successful investing should be boring, it doesn’t happen overnight but doing the right things daily over time enables you to reach your goals. Listen to hear all five of these principles in more detail.

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