Investing is a great way to increase your net worth and reach your financial goals. However, there are numerous risks involved with investing in the stock market that many people tend to overlook. We hear about the great investors – Peter Lynch, Warren Buffett, etc – and about the scammers, we need to avoid – think Bernie Madoff – but very few people understand what actually makes a successful investor successful. Below are several key ingredients which will improve any investor’s performance.
Focus on What You Can Control
There are many factors which influence the performance of your investments. Whether it is market volatility, economic events, politics, interest rates, or natural disasters, you can bet that you will probably have to deal with at least some of these in the course of your investing life. You can’t predict these; you can’t control these factors. But you can control how you react to these factors.
Let Time Work For You
Time is your greatest ally. You can’t control time, of course, but you can decide that you’re a long-term investor because you know that the value of compounding returns over time is one of the most powerful ways to build wealth. The history of the markets over several hundred years is almost irrefutable evidence of this simple truth. Even Albert Einstein once commented that “compound interest is the eighth wonder of the world”. Give your investment portfolio enough time to be successful.
Tune Out the Noise
The popular press should never be a primary source for investment data or the basis of any decision-making. Papers, magazines, television and radio shows are flooded with headlines designed to spark anxiety, shock and/or titillate. The articles and commentaries are rarely meant to provide the unvarnished truth, let alone detailed, accurate analysis. The information you need will require some digging and dedication. It’s out there, but it’s often lost amongst all the white noise clamoring for your attention. Knowing what’s truly important is a learned skill. People aren’t born with it. If you don’t want to learn how to do this, then hire a professional who does.
Avoid “Secret” Information Or Formulas And Don’t Try To Time The Markets
Television, radio and the papers regularly feature advertisers claiming to have a new secret investment formula, or to have advance certain knowledge of the next market upswing or downturn. Nobody on any of the various lists of the richest people in the world is on that list because of a secret investment formula or from success in timing the market. Furthermore, nobody on those lists even knows someone who has successfully timed the markets. One research study demonstrated that during a 10-year period of time investing if you mistimed the market just 4% of the time, you’d have earned less than Treasury bonds but wouldn’t have eliminated any of the risks.
Understand The Risks Involved
When people think of investment risk, they often associate this with the possibility of their portfolio losing money. However, there are many other forms of risk which are just as critical: inflation, longer lifespans, and the rising cost of healthcare can all decimate your portfolio. Most people underestimate how long they will need to rely on their investments and under-estimate how much they will have to withdraw to live over this long period of time. If you do not have a portfolio structure which balances all risks, your financial plan is built on shifting sand.
Accept The Emotional Roller Coaster
Emotional decision-making can wreak havoc on your investment portfolio. As much as we all think we’re rational intelligent investors, every one of us is still subject to our emotions, and they can be more powerful than we realize.
A study by Morningstar showed that over a 10-year period the average return of all the stock mutual funds was about 10% per year. Can you guess what the average return was of the average investor in these stock mutual funds? 10%, 8%, 4%??
The answer is negative 2% per year. That’s right. While the average return for the funds was 10% per year, the actual experience of the investors in those funds was a loss of 2% per year. Why? Because they typically bought when prices were rising (greed), sold when prices were falling (fear), and repeated that habit over all 10 years. Buying high and selling low has never been a successful strategy, but it is a very emotionally fulfilling one. That’s why you need to accept the roller coaster without making decisions based on each rise and fall. Investing for the long-run is key.
Savings are King
Very few people have become successful due to a one-time windfall or inheritance. Even people who get that bonus, win some prize or receive a substantial inheritance find that they still need to consistently build their nest eggs. Regularly contributing to your investment portfolio provides the seeds and nutrients necessary for real growth. You must save regularly during your life. The only way to do that is to spend less than you make. It’s not rocket science, as they say, but it is powerful.
Don’t be Afraid to Ask for Help
Nobody knows everything. We all have our limitations. The important thing is to know what you don’t know. If you’re not good at carpentry, hire a carpenter. When you’re not a doctor, don’t set your own broken bones. If you’re not a lawyer, don’t represent yourself in court. And if you’re not a professional investor, please don’t make critical investment decisions without the guidance of an objective and practiced advisor.