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Education, News, and Analysis for DIY Investors

The Importance Of A Proper Investment Plan

Most “do-it-yourself” investors fail miserably over the long-term.  As a matter of fact, the majority of professional investors fail to beat the returns of the broader market indices every year.  That said, there is one common trait that every successful investor shares…an investment plan!

Unfortunately, simply setting up an investment plan isn’t enough to succeed these days.  You also have to have the discipline to carry out that plan (come rain or shine).  Contrary to popular belief, the market does not control your investment success…you do!

Be True To Yourself And Keep It Simple

Even though death and taxes are the only guarantees in life, a proper investment plan should drastically improve your odds of long-term success.  However, it is unlikely that you will stick to your plan unless it fits your personality and you truly believe in it.  Some investors consider the term “trader” a four-letter word.  It’s just not in their DNA to actively trade their investment capital.  On the other hand, some investors classify a position that they hold overnight as “long-term.”  There are no right or wrong answers when it comes to one’s investment beliefs and investment plans will be as unique as the investors themselves.  That said, your plan should only include strategies and time frames that you are comfortable executing.  Be honest with yourself!

We all know that emotions cloud our decision making, which is why it is critical to keep these emotions in check by establishing concrete, simple rules for investing.  If your rules are too complex, you are setting yourself up for failure because you probably will not be able to follow them consistently.  The best advice that we can give investors regarding an investment plan is to write down your rules and follow them religiously!

4 Principles Of A Proper Investment Plan

We started Parsimony Investment Research to share our experiences, strategies and research with fellow DIY investors and we can’t stress the importance of establishing a proper investment plan enough.  Planning is the most important part of the investing process, yet most investors spend the least amount of time on it (if any time at all).  Clearly, planning is not as much fun as buying a stock…but it is 10 times more important!

Without further ado, below are our 4 key principles of a proper investment plan (in order of importance):

  1. Asset Allocation/Position Sizing (i.e., how much should you buy of each stock?)
  2. Exit Strategy/Risk Management (i.e., when should you exit a stock or hedge your portfolio?)
  3. Stock Selection (i.e., which stocks should you choose for your portfolio?)
  4. Entry Strategy (i.e., when should you buy a specific stock?)

Asset Allocation/Position Sizing

Dr. Van K. Tharp, a renown author and investing coach, originally coined the term “position sizing”. Dr. Tharp adamantly believes that poor position sizing is the #1 reason why investors fail to succeed. In other words, investors often fail due to an abnormally large position going sideways, which ends up sending their portfolio into a downward spiral that is almost impossible to recover from.  By diversifying your portfolio, you reduce the risk that one stock or industry derails your entire long-term investment plan.

Key rules to consider for your plan:

  • Maximum position size – In general, we believe that no position should account for more than 5% of your total portfolio.
  • Maximum industry/asset concentrations – Ideally, investors should also limit their exposures to specific industries and/or asset classes.

Exit Strategy/Risk Management

Even though most investors focus more energy on their entry strategy, your exit strategy is really the driver of long-term investment success. Exiting a bad position or hedging your portfolio at the appropriate time is what keeps you in the game long enough to win.  Investors need capital to survive and proper risk management strategies will offer excellent downside protection to your portfolio when you need it most.

Key rules to consider for your plan:

  • Maximum loss (position) – Investors should establish a maximum loss (or stop loss) for every position and stick to it…no questions asked!
  • Maximum loss (portfolio) – It is also important to establish a maximum portfolio loss as well as a hedging strategy to help manage this risk.

Stock Selection

We passionately believe that investors can manage their own portfolios and establishing a process for selecting the right stocks is an important part of the puzzle.  We like to use a combination of fundamental and technical analysis to determine which stocks to buy and when to buy them.  For example, we have a proprietary rating system that ranks over 700 U.S. dividend stocks on a monthly basis for our DIY Dividend Portfolio.  Our goal is to identify, research, and invest in the dividend stocks that we feel have the best risk/reward profiles.

Whether or not you use our rating system to select and monitor stocks for your own portfolio, we encourage you to create and define a stock selection strategy for yourself and have the discipline to carry it out.

Entry Strategy

We believe that patience is a virtue.  For example, just because a particular stock has a high Parsimony composite rating, it does not necessarily mean that you should run out and purchase it that day. We scan the charts of our top-rated stocks daily looking for strong levels of support and resistance, which ultimately helps us determine a target “Buy Zone” for each stock. We believe that patiently waiting for a low-risk entry point for a given stock will drastically improve your long-term investment results.  In other words, we use fundamentals to decide WHICH stocks to buy and we use technicals to decide WHEN to buy those stocks.

We focus on four key levels of support when determining a “Buy Zone” for our DIY Dividend Portfolio stocks:

  • Technical – Support from short and long-term trend lines
  • Volatility – Target correction levels based on historical volatility and draw down
  • Valuation – Support levels based on historical valuation multiples
  • Yield – Support levels based on forward dividend yield

If you are a new investor and are building a portfolio from scratch, do not feel pressured to have a fully diversified portfolio on day one.  Investing is a marathon, not a sprint.  It’s extremely important to be patient when building a long-term portfolio…we can’t stress that enough.


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