Rule Your Own Investments

People love to argue about rules. No matter the context, whether it's laws, elements of a sporting event or commonsense guidelines, there's little question that some people want to fight a system while others want to embrace it.

When it comes to investing, there are few actual rules — aside from legal and tax strictures — and a lot of suggestions, proposals, theories and disciplines that ordinary folks can follow. The question every investor needs to wrestle with is which rules they want to adopt and which ones they want to ignore.

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Last weekend, I hooked up with some old friends, and we all had stories of investment success from simply following our own rules. One unloaded some company stock because he had a personal limit of 10 percent of his total portfolio in any one investment; when the company stock crossed the line during a run-up, he cut back to his original allocation (5 percent), locking in a big chunk of profits and keeping his gains when the company faltered. Another talked about success he has had altering his retirement plan each year by rotating into the worst-performing funds available in the plan (he buys last year's losers the first week of each year and has been rewarded over time for being contrarian).

The conversation also turned to two of the hottest investment books out right now, tomes which are all about rules and discipline.

Phil Town's "Rule #1" is all about value investing, and provides a pretty simple formula an investor can use. (It boils down to "Find a great business. Determine the worth of the business. Buy it whenever it is trading at half of that value.")

Money manager Fred Kobrick counters with "The Big Money," a book that really is all about growth investing. Kobrick's focus is on four factors he calls BASM — "business model, assumptions, strategy and management."

No single right answer

It would be easy to assume that one side or the other must be right, or that it has uncovered the best discipline for making money, but the truth is a lot more boring than that. In reality, almost any investment system has its benefits, so long as the rules are applied smartly.

"I don't want to get bogged down in rules to where every decision is driven by fixed thinking, but I do think that people need to have a discipline, something they believe in and have faith in and that works for them," says Tom McIntyre of McIntyre, Freedman & Flynn, a money-management firm in Orleans, Mass. "The thing is coming up with a system that you trust, so that you're not just flopping around, going from one rule to the next thinking that all of these things work."

Kobrick noted in an interview that "you need a compass to go along the right trail, and having disciplines gives you a direction." While Kobrick has his favorite direction — growth investing — he did note that there are many paths to the ultimate destination, financial success.

Having rules is more detailed than saying "Own investments that make money." It involves terms and conditions that you want present in an investment, or that you want to avoid. The point is not that one rule needs to be your top priority, but rather that each investor should come up with a series of disciplines that guide purchase and sale decisions. Having those fundamental guidelines in place makes the rest of the process easier.

Investors who lack a comfortable structure for making decisions tend to wind up relying too heavily on others. They'll take advice they hear on a television or radio show and hang on too long because they haven't heard the pundit give a sell signal (or, worse yet, missed the broadcast when the expert backed out of the stock and couldn't recognize on their own that it was time to go).

Kobrick noted that investors are drowning in information and frequently don't know what to do with it. For most, that's because they lack some rules or a system that helps them determine which information is worth acting on.

So write down the rules you would like to live by. Axioms like "buy low, sell high" are worthless unless you can be specific about how you intend to achieve that result. That might be by following Town's Rule #1 or by searching for Kobrick's BASM, but lay out the things you value the most.

Maybe it's a clean balance sheet, a stock trading below fair-value estimates, a continuous and strong dividend, a history of consistent growth or something else. On a mutual fund, it might be steady returns and a long manager tenure.

From a portfolio-management standpoint, rules might include rebalancing a portfolio when it moves five or 10 percentage points away from target levels, limiting exposure to any one sector to 20 percent and so on.

Use guidelines developed by someone else — as in the current books — or come up with your own. Your disciplines do not have to be completely hard and fast, but they should be guideposts that allow you to make decisions that feel grounded and smart, rather than floundering around trying a little bit of every strategy and hoping it amounts to something good.

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