Back in the 1980’s and early 1990’s I was the Data Center Operations Manager and then the Operations Director for a large food ingredient manufacturer. During those mainframe computing days, the key systems behind the glass doors of the computer room were the computers, the cooling systems, the power systems and the fire protection systems. In those days, Halon gas was the state-of-the-art solution. If a sensor detected smoke or fire, a countdown would begin. At the end of the countdown, the Halon gas would be released with great force. This was a wonderful thing to suppress a fire, as water would do considerable damage to the systems in the computer room. However, if the system triggered for a non-fire event (like a workman who created some smoke while working in the room) we did not want the expensive gas released. This system would also shut down the computers, and that would have been a huge mess. So on the wall, near the exit was a button you could press and hold until the problem was resolved and the alarm was reset.
In the investing world, it is wise to have safety mechanisms in place. Most of the time your best course of action is the “do nothing” approach. You don’t want to panic sell, so you should have an “Investment Preservation” button. The best button is to have a written investment plan. While this sounds complicated, it doesn’t have to be. You just need to think about your reasons for buying an investment and any rules that would cause you to trigger a sell of those same investments.
Let me suggest five written rules you should have:
Five Rules for Wise Investors:
- Buy only quality stocks, ETFs and index mutual fund investments. In other words, avoid junk and high-risk investments. If there is a new trend in something, like the bitcoin, be very skeptical. If the P/E ratio is greater than 20, then ask: “Do potential future earnings support this high P/E?”
- Look for dividend growth investments supported by growing earnings. Buy them.
- Do not forget to diversify your holdings. The easiest way to do this is to buy an ETF like VYM or an index fund like FXAIX or FSKAX. FXAIX is the Fidelity® 500 Index Fund. FSKAX is Fidelity® Total Market Index Fund. Both have a low expense ratio.
- Avoid the temptation to buy “safe” investments like money market funds and government bonds.
- Sell any investment that has clearly failed in your requirements. In other words, if you hold and investment that you would not buy more of today, then consider selling. For example, if you look for dividend growth and a company reduces or eliminates their dividend, then sell. Take the loss. Don’t hesitate.
One final word: avoid putting in stop loss orders. A stop loss order says “sell this investment if the price drops to $xx. Those might make sense in some rare situations, but volatility can stop you out of a position at the wrong time. A stop loss order is often a poor emergency button.