These were my rules I pulled together for the Washington Post:

1. Cut your losers short, and let your winners run.
2. Avoid predictions and forecasts
3. Understand crowd behavior.
4. Think like a contrarian (but don’t always act like a contrarian).
5. Asset allocation is crucial.
6. Decide if you are an active or passive investor.
7. Understand your own psychological make up.
8. Admit when you are wrong.
9. Understand the cycles of the financial world.
10. Be intellectually curious.
11. Reduce investing friction.
12. There is no free lunch.

The first half is here, second half here.

Category: Investing, Rules

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

25 Responses to “Ritholtz’s Dozen Rules for Investors”

  1. Nuggz says:

    “2. Avoid predictions and forecasts”

    Well, that pretty much sticks a fork into the financial twittersphere.

    What will they do with all that extra time?!

  2. capitalistic says:

    # 2 and, #3, #10 and #12 are very important

  3. hast2307 says:

    Barry,
    On rule number one, what is your rule of thumb on length of time before cutting losers?

  4. hast2307

    It depends upon the circumstances — more a function of percentage than time — but cutting losses has lots of goals:

    1. You are forced to admit your own fallibility (crucial for all traders).
    2. It rotates you away from the sectors and stocks that are not working.
    3. It requires you to develop a repeatable process (vs random outcomes)
    4. It avoids catastrophic losses in any given position
    5. It forces you to be humble.

  5. Bob A says:

    I WANT a free lunch.

  6. ZenRazor says:

    At least for me, 1, 7 and 8 are closely intertwined. There are a subset of positions I buy/short with a lot of research behind them. When these positions move against me my first bias is to add to them rather than cut them. Part of that is a function of my psychological make up (#7). But when I add to a losing position I always do it with a specific risk limit in mind that defines when I’m wrong (#8). On balance, many of my best gains have come by violating #1. (And it is important to measure such things so your memory doesn’t become selective on what works and what doesn’t.)

    I will not, however, permit inaction when a position has moved decidedly against me. If it is losing a material amount of money, it either needs to be added to or cut. This rule helps avoid the behavioral bias against acknowledging/taking losses, which is an important component of #1.

  7. Potomac says:

    #8 for all those who claimed the Fiscal Cliff is overblown…we’ll find out tomorrow and Wednesday…

  8. b_thunder says:

    What about “buy low, sell high”, aka the “original” Buffet rule?

    I wonder if Mr. Ritholtz more in favor of that, or more in favor of a certain CNBC entertainer’s “buy high, sell to a greater fool.” Or if both are valid rules to follow?

  9. SEG says:

    2. Avoid predictions and forecasts

    ?????? OK lets log off and go home

    3. Understand crowd behavior.
    3. Understand crowd behavior.
    3. Understand crowd behavior.

    Can’t say that enough.

    7. Understand your own psychological make up.

    AMEN

    12. There is no free lunch.

    Actually, there is very rarely a free lunch. If you tell any one about the free lunch, it will end.

    People who regularly beat the market (and they are very few) have identified one or more equivalents of a free lunch. Most readers will identify few or no free lunches.

    You can argue with me all you want but the money some people have made did not fall from the sky.

  10. BR,

    shouldn’t #8, be #1 (at least, b/c it is Key to (the current) #1, at the min.)?

  11. theexpertisin says:

    An observation, not a rule:

    Investing can become an obsession. Investors should understand that there is a life to lead outside of investing. Within one’s means, live it to the fullest. Don’t let a brokerage account become your best friend.

  12. faulkner says:

    Barry, your exchange with hast2307 is a nice example of how succinct advice is not necessarily simple.

    hast2307 asked you for “your rule of thumb” on rule #1 – which assumes a single rule for all circumstances. You replied “It depends upon the circumstances” – assuming there are several, and then went onto redefine circumstance as “more a function of percentage than time,” adding “but cutting losses has lots of goals” where hast2307′s question had just one. Then you unpacked 5 ongoing practices, not even suggested by your list, that are inherit in the application of rule #1.

    A treasure trove to be sure, and an ample demonstration that investors are often on different levels of development. In my modeling, hast2307′s question was levels 2-3 while your answer was level 5.

    I expect you could do the same with the other 11 rules as you did with #1. It would be interesting to the rest of us.

  13. faulkner

    Funny you mentioned that — its an ongoing project I have been working on — taking all of the various rules I’ve accumulated over the years, and expanding them in the same way.

    It probably won’t be ready until late Q1 / early Q2.

  14. James Cameron says:

    > #8 for all those who claimed the Fiscal Cliff is overblown…we’ll find out tomorrow and Wednesday…

    Or maybe we won’t if they think sufficient progress is being made . . . that said, I have little doubt that the markets will take a hit if there’s little evidence of progress in the days a head. And that may not be such a bad thing . . .

  15. Lukey says:

    An excellent list Barry. I especially like 11 – Reduce Friction. I work in philanthropy and I can’t tell you how many times we see endowments where they hire an adviser to help them choose a manager who then helps them select mutual funds. And yes, for those of you scoring at home, that is three levels of fees on the same investment!

  16. Greg0658 says:

    I wrote a piece mentioned at 9:37am
    http://www.ritholtz.com/blog/2011/01/the-anti-regulators-are-the-job-killers/
    These past years and reflecting back in this new galactic year, that Feb’04 was the near top in my space and probably the spot I should have started to sell out. But to where .. since my investing is in property & stuff. Wake’g this morning on a near’g mission to rescue an abandoned in place (overnight) pov (quadrunner) .. sometimes things can go badly and abandon in place is a real possibility .. a warning shot (again) and cry for assistance (again) as the muck gets deeper and deeper .. that Anatevka wagon looks and sounds depressing

  17. BusSchDean says:

    >#8 and the fiscal cliff

    Maybe going over the fiscal cliff IS an example of #8. For all of those who believe or want to bet that enough of our politicians can put our collective interests, financial and otherwise, above narrow interests. Surely we have some but for those who think we have enough this is #8.

    Post-cliff (more like a small waterfall just big enough to get everyone wet for a bit), those politicians who cannot hold onto more than one idea at a time can perhaps focus on one piece of the problem at a time. The situation is frustrating but not dire. The middle class is trashed either way — a post-cliff tax break for them will help but no tax policy will change their situation long term.

  18. Jim67545 says:

    On #1 you outlined your rules for cutting losses short. What about when to sell those you’ve let run and which are either still rising or have turned down.

  19. Jim67545

    Also complicated — there are lots of elements to put into this:

    1) How is the stock behaving?
    2) What does the valuation look like?
    3) What is the rest of the sector and market doing?
    4) How weak/strong is macro environment
    5) What are the directions of interest rates?
    etc.

    See also Justin Mamis, When to Sell

  20. faulkner says:

    Re: Expanding on all the various investor rules. Excellent! When it’s published, do not be surprised at the amount of anguish expressed along with the accolades. Traders and investors at the lower levels, which are the vast majority, cannot believe how much work those on higher levels are doing. Easier to attribute it to prescient insight or insider information. And thus an entire industry sustains itself.

  21. faulkner says:

    Jim67545

    Re: rules for cutting losses short

    A bit of “information architecture” and more unstated –

    First, Barry’s list is a series of somewhat nested frames starting with the inner most one.

    1) How is the stock behaving? (relative to previous behaviors over unspecified periods of time)
    2) What does the valuation look like? (unstated whether this is a benchmark, anchor or relative value)
    3) What is the rest of the sector and market doing? (doing what and doing time frame are unspecified)
    4) How weak/strong is macro environment (factors for determining weak/strong environ unspecified)
    5) What are the directions of interest rates? (note plurals – multiple rates and directions. How to use this?)
    etc.

    Justin Mamis book “When to Sell” is great as well as a pleasure to read.

    “It’s all there in black and white. It’s just more in the white than in the black.”

  22. Greg0658 says:

    faulk I’m back – the pov extraction went much better than expected – that 9:27am – from an old HVAC’r pov
    (point of view & privately owned vehicle)
    it helps to know the fan output, the constriction in the ducts, the size of the register openings .. then the exhaust capability of the bathroom/kitchen hood, the makeup duct in that kitchen space, the tightness of the doors and windows, the body heat generated by the humans (eat’g, play’g sluff’g), the lights and other energy hogs hense heat generated
    long story to say:
    the temperature outside is important – but system control and gauges in the lines make the regulation optimal .. HFT is a benefit to the connected in this modern OpSys

    but go off the grid .. what you takin bout Willis

  23. Jim67545 says:

    BR: Thanks for reply. Have a happy and prosperous 2013!

  24. Greg0658 says:

    wonder’g about: the official records of stock certificates – bond certificates .. is there a third party that keeps said records besides the buyer & the seller .. like a government official who knows all the wealth (on paper) here-there-everywhere

    “possession is 9/10th’s of the law .. the last 1/10th is for TheBar to figure out” c2012Me (maybe earlier-probably)