Personal Investing 101
The stock market should be seen as a path to lifetime success rather than instant success. In order to be a successful investor you must understand what is realistic and what isn’t and most of all, make time your most valuable asset rather than wasting it.
Market timing does not guarantee a higher return on your investments in fact it usually reduces your return due to market timing errors and the associated higher trading costs. Depending on the time you have available and the level of personal interest you have in this subject, you can either make investing as simple or as complex as you like. I believe the key is to keep it simple. Once you have completed your basic research and identified the asset allocation that best fits your goal, put it in autopilot and simply do periodic maintenance to keep the allocation aligned your initial goal.
Of course analyzing stocks and identifying the ones that you value most is both stimulating and interesting but it absorbs a lot of time and it is not the appropriate path for most investors. As William J. Berstein says “Most investors are unaware of the investment terrain. Without an understanding of the relationship between risk and reward, how to estimate returns, the interplay between other investors and themselves, and the mechanics of portfolio design, they are doomed to failure.”
So why should you attempt to identify and select individual stocks when there are so many factors to consider and in the end the future is not predictable? You might be lucky and make a decent profit on a few stocks but this good fortune highly unlikely to continue over the long run. Most individual investors would be better off investing in index funds which allow you to diversify your portfolio, thus reducing risk, and also have very low associated costs since they are not actively managed mutual funds which tend to be significantly more expensive. If you want to be a better investor than the vast majority of people trying to make money in the stock market keep the following in mind:
Time is your friend
Rather than “wasting” your time searching for the next hot stock that you think will make you rich overnight, invest for the long-term in order to reduce the overall risk of your portfolio (make sure to have a well-diversified portfolio) and take advantage of compound interest. In order increase the opportunity to increase your investment capital you need to increase the amount of time you are investing. Investing time can only be increased two ways, by starting earlier or retiring later. The longer the time frame the greater the positive impact compound interest will have on your portfolio.
Impulse is your enemy
Do not overreact to the stock market’s fluctuations. Stick to your original plan and you will be fine over the long run. Throughout your “investing career” you should expect one or two bear markets and if we analyze the historical stock returns, we’ll notice that the market can perform poorly for periods as long as 15-20 years. Do not scramble to outperform the market but simply establish and most of all stick to your initial investment plan.
Basic arithmetic works
Simply focus on time, savings rate and rate of return. The longer the number of years, the greater will be the impact of compound interest. The more capital you are able to save and put into your investment program, the greater the potential growth of your portfolio. You will not be able to build wealth if you first do not pay yourself so make sure every month you are able to put a certain amount aside in order to meet your overall investment objective. The amount will depend on your expenses and your lifestyle but in order to generate the cash to build your investment program you will have to live below your means. I’ve always wanted to own a BMW and although I could cover this expense with my salary, I preferred buying a less expensive car which enables me to use that extra cash to add more capital to my investment program in order to be better off when I retire. Personally, I try to put 15-20% of my income into my investment program. If you are not be able to do that immediately, try building up to this amount over time and you will be pleasantly surprised by the positive impact compound interest will have on your portfolio over time. The rate of return of your investment is directly correlated to the level of associated risk you assume. The greater the risk the higher the potential return. You increase the mount of risk in your portfolio by increasing the percentage of stocks and reducing the percentage of bonds and cash equivalents. By investing in relatively safe investment vehicles and for short time periods, you will limit your potential return.
Stay the course
According to John Bogle, “The essential characteristics of the successful investor are the discipline and stamina to stay the course”. If you haven’t already done so, I strongly advise you read the book “The Four Pillars of Investing” by William Bernstein. This is a must read if you are taking investing seriously and is one of the best books I’ve ever read.
Now that you have a basic understanding of the principles of personal investing make sure you have a clear investment goal in mind, manage your risk by staying with an appropriate asset allocation strategy, make a long-term commitment to low-cost investing and most important of all stay the course when things get rough.