As we approach nine years of a bull market, it’s important to pause and review the keys to successful investing over a lifetime. Success in a bull market is not that difficult but creating success over a lifetime is a challenge that most individual investors will fail…and fail miserably. According to one study, the average investor earned a measly 1.7% annualized return over a 30-year period. Why do these investors perform so poorly? In one word: psychology.
When you study legendary investors such as Warren Buffett (stocks) and Bill Gross (bonds), you’ll find several common themes that are part of their success.
Understand & Manage Risk. These pros understand the characteristics of risks related to equity and fixed income investments. For example, investing in a money market account involves minimal risks and produces very low returns. Bank CDs typically offer higher returns but less liquidity. With short-term, high quality bonds (or bond funds), you will experience some, but typically relatively low volatility in values…meaning if you invest $10,000, your account value can fluctuate modestly up or down over time. Invest in junk bonds and you can experience very wide changes in value. With stocks, big blue-chip dividend-paying stocks will tend to be significantly more stable than small company stocks of foreign countries. Even the most conservative of stock portfolios experiences a significant amount of volatility over short periods of time. This short-term volatility begins to dissipate over time (years). Professional investors understand this as well as the dynamics of changing risks as you mix stocks and bonds within a portfolio.
Adhere to an Investment Discipline. If you polled a dozen legendary investors, you’d likely find a dozen different buy/sell strategies. Since they are all successful at investing, what becomes clear is that it’s not the exact strategy that is critical to success, but rather the discipline of the strategy. Much of this confidence in a given strategy is based on the investor’s deep understanding of the short and long-term characteristics of risks of their particular strategy. They don’t rely on their ‘gut’ feelings for managing their portfolio, instead, they rely on their management ‘process’.
What, in my experience, doesn’t work is ‘timing’ the stock market…attempting to sell out of the market at or near market highs and then buying back in at or near market lows. I’ve seen lots of people try to do it, but I’ve never witnessed long-term success.
Exercise Patience. If market timing doesn’t work, what does work is patience. It goes back to having an investment ‘process’ (security selection; buy-side; sell-side process) and giving your process time to work. It also requires understanding that whatever the process you adopt, it’s not going to work all the time. My rule of thumb is that every worthy investment strategy will go through three phases. About one-third of the time it will work about like you expected; about one-third of the time you’ll look like a genius; and about one-third of the time it will look completely broken. This means that about two-thirds of the time you’re doing well and you just have to let patience and confidence in your strategy sustain you through the challenging period. Where most people get tripped up is that the period of time your strategy seems broken will typically span several years. Most people can live with one ‘bad’ year, maybe even two bad years but longer than that and they are ready to give up…and most novice investors will throw in the towel. And that’s when the real problem is just beginning. When they decide to change strategies, what strategy do they adopt? The ‘genius-looking’ strategy, of course! This is the one that may soon transition into the ‘broken’ strategy. Then they get discouraged and exit the stock market forever saying, “The stock market is too risky”.
Take a moment of self-examination and see if your past history of managing your investments checks all three of the above boxes. If not, consider making adjustments or consider hiring a professional money manager.