Everyone’s heard the song “The 12 Days of Christmas.” Since we’re in the midst of that season, it seems like an appropriate time to review “The 7 Wonders of the Investment World.” The difference is that the effect of these 7 “wonders” lasts a lot longer than 12 days. Or 12 months, for that matter.

Understanding how these 7 wonders work is a vital factor in portfolio management that will help you enhance your long-term results.

1. Compound interest — earning interest on interest — can have an enormous ballooning effect on the value of an investment over the long term, and lift the overall returns on your portfolio.

   This applies to equity investments like stocks, as well as to fixed-return, interest-paying investments like bonds. (In fact, stocks are generally preferable – see investment wonder #7.) When you earn a return on past returns, the value of your investment can multiply. Instead of simply rising at a steady rate, the number of dollars in your portfolio will grow at an accelerating rate.

   There are two conclusions you need to draw from this investment wonder in order to improve your portfolio management.

   First, you need to pay attention to steady drains on the capital in your portfolio, even seemingly small ones — like high brokerage commissions. This can eat up a surprisingly big chunk of your portfolio in a decade or two.

   Second, you can’t expect to earn an outsized return on an investment in your portfolio indefinitely. If you did, you’d wind up with a measurable fraction of all the money in the world, and nobody ever does that (see investment wonder #2).

2. Regression to the mean is inevitable.

   No investor and no investment can earn an outsized return indefinitely. Eventually, a high yearly return will come back down toward average. Sometimes, it will gain momentum and keep falling until it drops far below average, or turns into a loss in your portfolio.

Invest in your Financial Future for FREE Learn everything you need to know in '9 Secrets of Successful Wealth Management' for FREE from The Successful Investor. Secrets of Successful Wealth Management: 9 steps to the life you've always wanted, before and after retirement.  I consent to receiving information from The Successful Investor via email. I understand I can unsubscribe from these updates at any time.

3. No investment can ever be so attractively undervalued or desirable that it overcomes a lack of integrity on the part of company insiders.

   If you have any doubts about the integrity of insiders, sell immediately.

4. As a group, investment long shots are invariably overpriced.

   If you have nothing but long shots in your portfolio, you are likely to make meagre returns or lose money over long periods, instead of the high returns you seek. That’s why you need to be particularly cautious and selective when adding anything to your portfolio that offers the potential of high returns.

5. Financial incentives have an enormous impact on the beliefs of otherwise honest people, particularly when it comes to what they will say in order to spur you to buy something. If you fail to spot these conflicts of interest, it could be very damaging to your portfolio.

   We’re not just talking about stockbrokers. As the saying goes, never depend on your barber to admit that it’s too soon for you to get your hair cut.

6. The markets for fungible goods like oil, interest rates and gold are inherently unpredictable.

   Markets like these are so enormous that there is no practical limit to how much you can trade in them. It follows that if you could predict them, you could wind up acquiring a measurable proportion of all the money in the world, and as we’ve already noted, nobody ever does that. That’s why it’s a mistake to build your portfolio in such a way that you have to accurately predict the future direction of fungible goods like oil, interest rates or gold.

7. In any reasonably healthy economy, equities will always give you a higher return than bonds over long periods.

   There is a self-regulating mechanism at work that guarantees this. If it didn’t work that way, everybody would prefer bonds (with their predictable returns) over stocks (which have variable returns). Interest rates would then fall down toward zero, and virtually all the economy’s profits would flow to stockholders.

   That’s why it pays to invest in bonds only when you must have steady returns, or when interest rates are unusually high. The rest of the time, with rare exceptions, you’re better off in stocks.

   Today’s economy does qualify as a reasonably healthy one, in spite of the many media headlines insisting we are in constant crisis. Thus, wonder #7 continues to operate in favour of equities rather than bonds.

We have long employed these 7 wonders of the investment world in our investment philosophy that allows us to achieve greater gains without unnecessary risk. If you’d like me to personally apply my time-tested approach to your investments, you should consider becoming a client of my Successful Investor Wealth Management service. Click here to learn more.