The Common Sense Investor

Allocate your money intentionally by choosing good companies at cheap prices.

If you knew that investment A was going to provide you with a 12% annual average return, investment B was going to provide you with an 8% annual average return and investment C was going to provide you with a 5% annual average return, which investment would you pick? Well, if most of the sages of the investing world had their way, you’d take a little bit of each.

But we don’t think that makes any sense.

Why allocate your investment money across sectors that provide consistently weak returns? The whole purpose of investing is to acquire wealth, so you should be in the business of maximizing your average annual returns. But often we diminish our returns by blindly allocating across investment types and sectors.

Well, they say, you are hedging against risk. But that’s not totally true. As we’ve noted on this site before, risk is relative to time, and when you are investing over the long-term with the goal of maximizing your return, it is far more risky to keep your money in cash or bonds than it is to invest it in stocks.

Know where you are investing your money.

This is a mantra that we’ll repeat over and over at The Common Sense Investor. What we mean by this principle is that investing should be an intentional process. There is a reason that you should invest in stocks and not in cash (and really not even in bonds). Why? Because stocks, by their very nature, provide the best opportunity for acquiring wealth. Companies exert effort for their shareholders – they produce with the intention of maximizing shareholder return. That’s the goal of investing, isn’t it? Neither cash nor bonds have the force of company production behind them.

Allocating across sectors

Ok. So now you know that you should be intentional about where you invest and that the goal of all your investments should be to maximize returns, usually by means of stock equities. So with that in mind, ask yourself whether it makes sense to allocate by sector or even cap-type? Many financial advisers would have you believe that you should. Put a little money in Utilities, put some money in Real Estate, put some money in Big Caps, Small Caps, Mid Caps and Blends. But why should you do this? What’s the principle behind it? Well, you’ll often be told that it minimizes investment risk because if one sector does badly, the others will buffer the negative consequences.

But we see this as blind investing. You should minimize risk not by covering all your bases, but by being selective about your investments. It makes no sense to buy the stock of a poor company just because it falls into a certain asset sector. If a large number of companies in a particular sector are poor investment choices, then you should just plain avoid them. On the other hand, if a large number of companies in a single sector are good investment choices, then don’t be afraid to load up on them.

Don’t invest across sectors. Invest across good companies that sell at reasonable prices.

Annual Re-Allocation

We wholeheartedly agree that the common sense investor should actively monitor his investments. Investing needs to be intentional. So, an annual or 6 month checkup is certainly advisable. However, it is often recommended that you not only monitor your investments, but that you transfer money from the “over-performers†to the “under-performers.†We couldn’t imagine a more foolish investment strategy. The standard justification for doing this is that it keeps you from overweighting a particular sector or investment. But what it really ends up doing is overweighting lesser investments.

The mistaken belief is that an investment that has had recent success is more likely to stagnate or decline than an investment that has been doing badly. So take your harvest from the top and replant it in some other investment that has more room to grow (because it’s been doing poorly).

This is all absurd, of course. In my experience, good long-term investments can perform consistently well. Let them keep performing strongly.

The trick, of course, is in identifying the good long-term investments. But if you do the hard work at the beginning by allocating over good companies (rather than asset types or sectors), then you eliminate both the need and the justification for re-allocating your funds from over-performers. Just keep letting the over-performers over-perform.