This post may be different than what you were expecting. I don’t share any hidden secrets or 100% guaranteed stock tips that will improve the returns on your portfolio. But I do want to help you get out of your own way and invest with purpose so that you can be confident and comfortable with your investment process. Often, we are our own worst enemy when it comes to investing because we let our emotions get in the way, and doing so can cause us to make bad decisions. So here are a few tips to help you get started.
Investor or Trader
First of all, know the difference between an investor and a trader. Investors tend to have a longer time frame in regards to their investments. The methods they use are not typically used as short-term trading tools. Traders typically have a shorter-term time frame in mind. Whether day traders to swing traders, they may hold an investment for a few minutes or a month. They also use options much more frequently. Option trading is a more difficult process and requires significantly more knowledge and experience to be successful. Generally, options are not available to people who are investing for the long term. The focus of this post is on investors.
Know Who You Are
Investing is not a cookie cutter process. Everyone is different and has different goals. True, there can be some similarities between people’s goals, but their risk tolerance differences could cause their approach to be much different. Also, different personality types can create differences in how the same portfolio performs over the long term. Do you recognize any of your tendencies in these groups below?
- Control Issues
- If you have control issues, investing can be a challenging. The stock market moves up and down on its own based on decisions made, whether good or bad, by investors and traders everywhere in the world. Decisions you make today will have no effect on how the markets react tomorrow. If you come to the table expecting complete control, your frustration will likely overwhelm you.
- Avoidance Issues
- How many of you look at your statements only when the market is doing well? But when markets are trending down, you just throw the monthly statement into a drawer out of fear of what you will see. Maybe you leave your deposits in cash as the market climbs because you’re afraid of the next market correction.
- Impatience
- Maybe you panic too quickly and sell everything into cash at the first sign of trouble. Or maybe you’re too anxious and go all in too early because you have FOMO (fear of missing out). Both signal impatience.
Dealing with these issues and other parts of our personality that can negatively affect our portfolio performance typically become a constant battle for most investors. How do we deal with this?
First, we need to recognize that the markets are out of our control. No matter what decisions we make today, we have no influence on these ups and downs in the markets tomorrow. Markets move as a result of decisions made by millions of investors, bankers, governments, multi-national companies, and more—all around the world. To think that we can have any modicum of control is unrealistic.
Second, we have to focus on what is within our control. Who you talk to and what you read and watch are all things you control. Friends only tell you about their good investments, not their losing trades. The media focuses only on the negative because bad news sells, and they have to sell ads. Assess where you are getting your information from, and think about where you can get better, more unbiased information to make your decisions.
Third, and most importantly, it’s all about what you do with that information. How do you take all that information and identify investing opportunities that have a risk level you’re comfortable with? Or how can you use that information to adapt to changing market conditions.
Risk Tolerance
Knowing your risk tolerance at any given time is extremely important to being able to control your emotions while investing and choosing opportunities that allow you sleep at night.
There are numerous online risk tolerance tests that you can search for that only take a few minutes to complete. With that information in hand, you can automatically include moves for your portfolio or rule out ideas that don’t meet your tolerance level. But it’s a good idea to retake these tests every few years or if your financial circumstances suddenly change dramatically. While we have a preference for how much risk we are willing to take, our capacity for taking risk can sometimes be more or less than what we would prefer depending on the current situation. Let’s look at an example of risk preference vs risk capacity:
If you are driving on the interstate on a warm, sunny day and the traffic is light, you might be willing to drive a little faster than the speed limit because the road is straight and you can see everything around you for miles. Even if you might normally drive a little slower than the speed limit, today you think you can speed it up a little for the same reasons. But what if there is more traffic or the road has more turns in it? What if it starts raining or, even worse, ice begins to form on the road? At this point, even the most aggressive driver is going to slow down regardless of their risk tolerance. The same is true with investing when markets begin to get volatile. So keep an eye on your risk tolerance.
Find A Process
Discipline is key to managing your portfolio. The easiest way to maintain discipline is to find an investing strategy you are comfortable with and understand. There are many types of strategies that have been published or are available online that typically have rules that explain the risk levels of investments and when you should buy or sell these investments. There’s no reason to get overly complicated with investing strategies. Any decisions you make should to be something you can understand—you’re not just taking somebody’s word for it.
One example is Trend Following using the 200-day moving average (dma). This is a long-term trend indicator that tells the investor whether the stock is in an uptrend or a downtrend. If the price is above the 200-dma, it is generally considered to be in an uptrend, and, if it is below the 200-dma, it is in a downtrend. As long as the investment is in the uptrend, the investor continues to own it. If it goes below the 200-dma, then the investment is sold.
Manage Your Own Investments or Get Help
As mentioned previously, you need to be comfortable in how you go about managing your investments. Some people have the bandwidth and discipline to take on managing their own portfolio. There are a number of investing platforms available online that have abundant research tools to help make decisions.
It’s no secret that the cost of hiring someone to manage your portfolio for you can have a significant impact on your returns, so it’s important to find someone that truly understands investing and isn’t just selling you a product.
Registered Investment Advisors (RIA)
Investment Advisors in RIA firms have a fiduciary responsibility to always do what is in the client’s best interest. They have a higher standard of transparency in regards to investments used and the costs associated with those investments and the service they provide. RIAs are paid an advisory fee directly from the client for advice and service, usually a percent of assets under their care. The fees are disclosed up front so there is no confusion as to what the cost is for their services. With this type of compensation system, RIAs are incentivized to protect and grow their client’s assets because they are directly tied to their client’s success.
Broker Dealers
A broker, or “Registered Representative” as they are sometimes called, is required only to recommend investments that are “suitable” for their clients. The suitability standard is less stringent than the fiduciary standard in terms of the advisor’s obligation to make recommendations that are in the client’s best interest. This means that a broker can legally put his or her own interest above yours when recommending financial products for your specific situation. Brokers typically follow the rules for legal disclosures, with prospectus booklets and lengthy legal documents printed in small-type in highly formal and hard-to-read language with the fees and other costs buried within the documentation. Brokers are paid by commissions, loads, 12b-1 fees, finder’s fees, and sales bonuses that are based on the type of securities and number of trades. No matter how the client’s investments perform, a broker is not tied to that performance financially. Also, brokerage firms are usually investment product manufacturers who see their broker/employees as the prime distribution channel to sell their products.
RIAs are the investment professional making recommendations, and clients have direct access to the decision maker. Investment and allocation decisions are made in a coordinated effort between advisor and client. Broker dealers are often set up in accounting firms and insurance agencies as part of the many services they offer as a jack-of-all-trades.
The most frustrating part of investing is when you are your own worst enemy. Take the time to understand what level of risk you are comfortable with and realize you don’t control the market. But you can set up processes and strategies that will keep your emotions from causing you to make bad decisions.
This post is for informational purposes only. It is not intended as investment advice as each person’s financial situation is different. I strongly recommend working with a financial advisor who can deliver current information to you quickly and offer help with sorting through the various investing options. Bret Wilson is a Financial Advisor with Wilson Investment Services, based in Rockwall, Texas.
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