James Cloonan's 10 Commandments for Investing

Join Wayne A. Thorp on October 31, 2023, at the MoneyShow in Orlando, Florida, as we explore “Understanding How to Interpret and Use Investor Sentiment,” drawing from AAII’s long-running Investor Sentiment Survey. The session concludes with a fresh approach to “Sustainable Growth Investing.” Click here for more information.

As I was going through old files at the AAII office, I came across one of AAII founder James Cloonan’s Matter of Opinion columns I had saved. This specific article contained 10 commandments he believed “should improve the investment results of all ‘long-term’ investors.’” They were written in response to a member’s request for “easier and more understandable advice” regarding investing.

Here are Jim’s rules as they appeared in the December 1981 AAII Journal:

1. Diversify—The amount you have invested in the stock market should be spread reasonably equally among at least seven stocks.

2. Never buy preferred stock (convertibles excluded) unless you are a corporation.

3. Never put a substantial portion of your wealth in the stock market or take it out at one point in time. Ease in. Ease out.

4. Never invest any money in common stocks that you feel you will need in less than four years.

5. Never buy a stock that is getting favorable publicity in the press.

6. Never buy a stock that is recommended on a non-solicited basis by a brokerage firm.

7. Never buy a stock that is included in the S&P 500 index.

8. Never buy “safe” or low-risk stocks. Establish a suitable risk level between growth stocks and minimal risk debt securities.

9. Don’t buy a stock in the year following a presidential inauguration.

10. Don’t believe in anyone else’s system for making a “killing” in the market. If you find such a system, write me “confidential” from your yacht and send your jet for me to come and discuss it.

Cloonan described these rules as applying to “almost every long-term investor.” He also acknowledged that many of them “will start a debate.”

I’ll add a few of my comments and observations.

Cloonan believed individual investors should take advantage of their ability to invest in small, undervalued stocks. He called these shadow stocks because they were overlooked by institutional investors, analysts and the media. As such, they existed in the “shadows” of Wall Street. This lack of attention leads to greater mispricing and more opportunity for capital appreciation.

In Cloonan’s terminology, growth stocks were not stocks experiencing strong increases in revenues and earnings. Rather, they were stocks with greater prospects for growing a portfolio’s value. Cloonan long advocated value approaches.

The suggestion for not risking dollars needed in four years or less carried through to his last book, “Investing at Level3” (AAII, 2016). In it, Cloonan suggested that retirees and those approaching retirement allocate between two and four years of living expenses to safe assets. Doing this allows a retiree to avoid having to sell stocks during a downturn.

Cloonan made modifications to his investing rules over time as more information became apparent. For instance, I never heard him guide against buying stocks during the second year of a presidential term in the eight years I worked with him. Nevertheless, there is a presidential cycle that coincides with stock returns. The second year of a presidential term has historically experienced the weakest average returns of the four-year term. The third year has historically been the strongest. We’re currently seeing this historical cycle play out now. The S&P 500 fared poorly in 2022 (President Biden’s second year) but has rebounded considerably this year (the third year of the current presidential cycle).

My favorite Cloonan rules were not part of these commandments. Rather, they were included in his October 2012 Model Shadow Stock Portfolio article (“Adherence to Rules Helps Model Shadow Stock Portfolio’s Performance,” AAII Journal). With his choice of bolding included: “Rule number one is: Develop a consistent, well-defined approach to investing in stocks. Rule number two is: Stick to it.”