What happened to prudent investing?

Just what is going on out there? I’m seeing individuals and couples every week that have fifty, sixty, seventy – up to eighty percent of their portfolios invested in stocks. When I see their brokerage statements, some are embarrassed, some are angry, some simply shrug their shoulders. It’s almost as if they are trapped in an investment prison and have no idea how to get out.
I live by a set of core principles I’ve learned throughout my life. Similarly, I invest using a set of core principles I’ve picked up by reading about investment theory and listening to successful investors. Many of these principles are tried and true…they are not groundbreaking or revolutionary. But, somehow, many of you have thrown them out the window in pursuit of bigger returns. I’d like to review the principles I believe should be followed by every prudent investor, especially those of you nearing or in retirement.
Principle #1: It’s more a rule of thumb, actually, but it goes something like this. For every year old you are, you should have a corresponding percentage of your entire portfolio in safe, low-risk or guaranteed income vehicles. So, if you are 60 years old and beginning to wind up your career, approximately 60% of your investable assets should be in fixed income or guaranteed return investments. Some examples of these types of investments might be bonds, annuities, CDs or life settlement contracts. The importance of this first principle cannot be ignored in times when the stock market is raging. As we have recently learned (again), you have no direct control over what happens in the equities markets. Having an inappropriately high percentage of your portfolio exposed to the risk of the markets can dramatically impact your overall wealth when bad market years come.
Principle #2: This is one I first picked up from my father-in-law over twenty years ago. He is an avid mutual fund investor. He researches the funds he is interested in. He compares their returns against their peers. He evaluates the holdings of the funds. He reviews the past performance of the fund manager. Once he decides to invest, he does something very important…he sets his stop loss targets. A stop loss is simply an arbitrary point at which you will stop losing money in the investment by selling it. For my father-in-law, his stop loss point is 9%. If the fund he buys loses more than 9% of its value, he dumps it – no matter what. The disciplined use of stop losses can help preserve your capital and help you “live to fight another day”. I know some of you are thinking that this principle can be ignored because the market always comes back, right? Well, I suppose you are right…but how long will it take? Suppose in 1985 you invested in the stock market index of the second largest GDP producer on the planet – Japan. The NIKKEI 225 hit its all-time high in late 1989 at 38,916. It has gone downhill ever since. As of this writing, the NIKKEI 225 is trading at 8,577. It has never even come close to its historic high in the intervening 19 years. Could the US equity markets be in for the same ride? Good old American optimism says no, but who could have predicted the DJIA falling to 7,882 in October of 2008?
Principle #3: Be engaged in your financial affairs. Question your advisors and their recommendations. As you get older, continually evaluate your exposure to risk and reallocate as necessary. Stay involved in the financial decision making. Educate yourself on financial affairs. Stay abreast of what is going on in the world from and economic and political standpoint. It’s your money! No one else will be as concerned about it as you are!