Here are some of the principles
that we follow.
1. Protect Your Capital
- Warren Buffett, arguably the most successful investor during the past
several decades, has two cardinal rules for investing. His first
cardinal rule is "Always protect your capital." His second cardinal
rule is "Never forget the first cardinal rule." The point is that it is
difficult to makeup a significant loss. For example, if a $500,000
portfolio suffers a $100,000 decline in value (i.e., 20%), it must
increase in value 25% to recoup the $100,000 loss. A decline of 50%
requires an increase in value of 100% to recoup the loss.
2.
Diversify -
Diversification protects our capital, substantially reduces risk and
increases the return on investment. Our balanced portfolios include a
variety of different classes of assets. These include stocks of U.S.
companies, stocks of foreign companies, U.S. Treasury securities,
high-quality corporate bonds, and cash or cash equivalents. In some
portfolios, other types of investments may also be included (e.g., real
estate or other investments). This diversification serves to reduce the
risk substantially. BAI also diversifies extensively within each asset
class (e.g., stocks, bonds, cash, etc.). This diversification acts to
reduce risk further.
For
example, before the U.S. stock
market crash in 1987, we sold stocks and bought bonds. This protected
our capital during the crash, while we made a great deal of money on
the increasing value of bonds. Studies have consistently shown that
more than 92% of investment performance is accounted for by the
selection of asset classes and only 8% by selection of individual
securities (e.g., stocks). For this reason, we place a great deal of
emphasis on deciding what proportion of our portfolios should be in
each asset class.
3.
Don't Be Too Greedy
- More money is lost by trying to achieve extremely high rates of
return or high current yields than for any other single reason. We
measure each client's risk tolerance and then develop portfolios that
maximize the return within his or her risk tolerance. Careful attention
to risk serves to preserve capital.
4.
Don't Be Too Conservative
- It is easy to "sit on" money and invest it only in cash or CD's.
However, there are two problems with this approach. First, the rates
available are at least 3-4% less than the return achievable with a
conservative balanced portfolio. Second, inflation will substantially
reduce the purchasing power of your principal. You may think you are
protecting your principal; actually, you are losing it to inflation.
5.
Minimize Transaction Costs
- Transaction costs can have a significant impact on one's rate of
return. Investing is never "free." On any investment transaction,
several people or organizations are being paid. It would require a book
to describe adequately how these costs enter into various transactions.
Transaction costs paid by our clients' average less than 10% of those
charged by a typical brokerage firm. This is because we have negotiated
sharply reduced commissions and use no-load products.
6.
Hedge Your Risk
- Betting all your money on expected changes in the stock market,
interest rates or any other single phenomenon is a fool's game. Hedging
your risk means assuming that the expected change might not occur. We
may allocate a significant portion of the portfolio to take advantage
of the expected change, but always position ourselves so that being
wrong does not unduly hurt us. Following this principle, our portfolios
typically have less than a 5% chance of losing capital in any year and
almost no chance of losing over more than one year. We want to make
money no matter what happens.
7.
Buy Only High Quality-
Low-quality investments are seductive, promising potentially higher
returns than high-quality investments. And we all hear stories of large
amounts of money being made on low-quality investments. Quality
produces higher returns over the long term and has lower risk. Remember
that there is a direct relationship between the possible return on
investment and the amount of risk that must be taken to achieve it.
Leave the junk or low quality investments to others. Quality will
produce the return desired with substantially less risk.
