6 Foundations for a Complete Investment System

This article is published with permission from InvestmentU.com.

In my last column I made the case that every investor should run his money using a proven investment system.

If you don't, you're just flying by the seat of your pants. And that isn't likely to deliver market-beating results.

A complete investment system should cover these 6 foundations:

1. It is based on a realistic philosophy

No one can consistently predict economic growth, interest rates or short-term market fluctuations. Instead, you should put together portfolios based on proven principles of wealth creation. That's how you build a fortune. And that's how you protect it, too.

2. It provides a specific asset allocation

How you divide your money up among different classes of assets—growth stocks, value stocks, small caps, foreign equities, bonds, TIPS, real-estate investment trusts and gold shares—is your single most important investment decision, responsible for as much as 90% of your annual return. Yet, in my experience, most investors don't even know what their asset allocation is.

3. It uses strict "Buy" criteria for every security

Sophisticated investors don't throw away money on hot tips and "stock stories." They invest according to hard-and-fast quantitative measures like sales, earnings, profit, and operating margins, debt-to-equity, credit quality, and yield-to-maturity.

4. It also maintains a specific "Sell" discipline

Anyone can plunk some money down for a fund or a few shares of stock. However, the art of investing is knowing when to get the heck out. With our funds, we rebalance annually, forcing us to sell high and buy low. With our stocks, we follow a trailing stop discipline, protecting both our principal and our profits.

5. It minimizes taxes and expenses

According to a Vanguard study, the average investor gives up 4% annually in taxes and expenses. That's way too much—and guaranteed to stunt your returns. That's why we recommend low-cost providers and offer an asset location strategy to minimize—or even eliminate—annual taxes on interest, dividends and capital gains.

6. It has a proven, verifiable track record

Listen to all the marketing copy and it seems like every investment newsletter editor is beating the tar out of the market. It reminds me of Garrison Keillor's fictional Lake Woebegone, where all the men are handsome, all the women are strong and all the children are above average. (Perhaps that's why the PGA requires a player's opponent to attest the card.)

Stick to a system

What is the alternative to using a proven investment system? Well, you can follow some guru's weekly forecasts. (And hear him explain as time goes by why he's not wrong, "just early.") Or you can accumulate stocks, bonds and funds willy-nilly with no overarching philosophy or strategy. Or you can hope you get lucky.

But you probably won't.

It takes a lifetime of hard work, sacrifice and thrift to build a substantial nest egg. Should you really treat it like chips in a poker game?

Every investor should use a proven, battle-tested investment system, one that maximizes your returns in the good times and safeguards your capital in the bad ones.

Alexander Green is the chief investment strategist at InvestmentU.com. See more articles by Alexander here.

The information contained in this article should not be construed as investment advice or as a solicitation to buy or sell any stock. Nothing published by Physician’s Money Digest should be considered personalized investment advice. Physician’s Money Digest, its writers and editors, and Intellisphere LLC and its employees are not responsible for errors and/or omissions.