Basic Investment Principles

Many of the widely held beliefs about long term investing are wrong. I believe that the principles listed here have some merit.

If you have read extensively about investing, you are acquainted with the principles that have survived rigorous examination. If you have not, a good place to start would be A Random Walk Down Wall Street by Burton G Malkiel.

The stock market outperforms real estate and bonds.

Although there have been years when stock market performance was inferior to that of real estate or bonds, over the decades the market has been the best performer.

Technical analysis is worthless.

Patterns, trendlines, and other technical tools have no forecasting significance. On rare occasions a technical tool has provided an edge, but the tool eventually became widely known and changed the market in a way that negated the edge.

Fundamental analysis is worthless.

Professional fund managers have a dismal track record. In fact, funds that attempt to select stocks do not do as well as funds that blindly build a portfolio that reflects a market index.

Earning higher returns entails higher risk.

Bonds tend to be safer that stocks or real estate, so have a lower return. What's more, the safer the bond the lower the return, so US Treasury securities have the lowest returns of any bonds while low-rated corporate bonds have the highest returns.

Real estate has a higher return than bonds because real estate is not backed by a government agency or a corporation, so carries a higher risk. Stocks have the highest return because stocks can be hammered by changing fundamental conditions, political demagoguery, or bad management, so are always subject to precipitous falls.

Diversification and cost averaging reduce risk.

Diversification means having a portfolio with a large number of stocks that move independently of each other. Cost averaging means investing periodically instead of all at once, minimizing the risk of investing heavily just before a large decline.

The market has an upward bias.

Although the market can have declines that last for years, over the decades the general trend of the market has been up. Thus, it is realistic to expect that the income from owning stocks will include both dividends and capital gains.

The market moves in exaggerated trends.

The average uptrend and the average downtrend in market indices and in individual stocks are greater than those of a random walk. This effect is small, so the expenses of commissions and bid-asked spreads would eliminate any profit from following trends.

The best stock market investment is an index fund.

Because market professionals cannot consistently select stocks that outperform the indices and because it is difficult to own enough stocks to provide adequate diversification, it is better to buy shares in an index fund than to buy individual stocks.

Buy and hold is the best strategy.

Do not sell stocks because you think there will be a substantial market decline. Market declines come unexpectedly, confounding almost everyone. Being out of the market in anticipation of a decline might cause you to miss a substantial advance.

Leonard Azar, 309 Oxford Street, Brookings, OR 97415 -- (541) 469-2429 -- e-mail