If you want to succeed in the stock investing game, you have to know yourself. This means knowing how you think, your behaviour patterns, and your emotional makeup.
I’m not saying it’s easy, objectively assessing yourself, questioning whether you’re as smart and beautiful and talented as you believe you are. Still, knowing what drives you in certain directions facilitates more effective decision-making and higher returns.
The Investor, The Bear and The Bull
For example, during the so-called Great Recession of 2008-2009, with doomsday soothsayers operating in overdrive, how did you respond? And was your response any different during the rapid fire, insane, this is the big one, run for the hills, market collapse of January/February 2016?
Did you believe that the end of capitalism was nigh? Did you run to your investment advisor demanding that he/she sell everything as clouds darkened? Did you bury your head, refuse to look at your monthly statements for fear of reading smaller and smaller numbers on the bottom line? Resign yourself to everlasting poverty? Dump your securities portfolio, buy gold, build a bunker, load up on hardware, ammo, spam and water?
Or, rather than allow fear and panic to rule, did you tap into your inner Buddha who calmly reminded you that Bear markets last an average of 18 months and lose an average of 40%. And after the Bear retreats? The Bulls charge the stage for an average of 97 months and, in that time, the 40% and a whole lot more is recouped.
You and Your Portfolio Should Fit Together
How you respond to roller coaster markets is hugely important. Because if fear or greed or anxiety or exuberance or any other heartfelt emotion are stressing you too much, recognize this about yourself. Understand how you respond to winning and losing investments, market run-ups and market meltdowns, and adjust your portfolio to suit your temperament.
The thing is, there is no right or wrong here. It’s just a matter of knowing who you are. With this knowledge, you may then figure out the degree of stress you are able/willing to manage and, related, what investments work best for you.
I mean, if you know that you get way too jittery when stock values start falling, then it’s best to build a portfolio that helps smooth the ride, i.e., larger cash and fixed income component, less exposure to individual stocks. If you want to be invested at least partly in stocks, then lean towards less volatile large caps and consider adding Index Funds for increased equity exposure.
On the other end of the emotional spectrum, if you get too hot and bothered when your portfolio is rising, and are prone to convincing yourself that all of your holdings have a one-way ticket to the moon, then know that about yourself too, and stick to a plan (drafted before you even purchase any particular stock) that says you will sell a certain percentage of your holdings at certain price points. Because for the most part, moonshots return to Earth with a thud.
Archetype #1: The Active Investor
Active investors buy and sell securities with a view to achieving a better return than market indexes (i.e., NASDAQ, S&P 500). This may certainly be accomplished.
But keep this in mind: investment management firms and advisors don’t tell you that it’s not often achieved on a consistent, year-over-year basis. In fact, more than about 80% of active fund managers perform worse than a range of Indexes over extended time periods, i.e., 2, 5, and 10 years. 80%! That’s a big ole’ whopping number that deserves your attention.
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Archetype #2: The Passive Investor
Passive investors typically buy and hold Index funds. The advantage here is that you pretty much earn a return equal to the return of the particular Index. The disadvantage is that you will not do better than the Index.
Still, for those who know that excessive risk or volatility is not their thing, and acknowledge that less than about 20% of Fund managers beat Indexes, then the safer, less volatile, preserve the nest egg approach to investing suggests that Index funds deserve a place in your portfolio.
Why Index Funds Are Your Friend
Index Funds represent a simple approach to investing. Nothing fancy, hip, cool, trendy, or anything to brag about. In fact, investing in Index Funds is typically a slow, steady and downright boring approach. And that’s exactly what most investors should seek out: a boring portfolio that makes you money.
But don’t just take my word for the benefits bestowed by Index Funds. Here’s what Warren Buffett said in his 2017 letter to Berkshire Hathaway shareholders:
“The bottom line: When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”
And get this: in 2008, Buffett made a 10-year bet with Protégé Partners. The wager was that an S&P 500 Index Fund would outperform a collection of hedge funds. This year, Buffett collected on his bet with his chosen Index Fund chalking up an 85.4% gain during the term of the bet, and the hedge funds returning a relatively measly 22%.
Play The Odds
Sure, equity Index Fund investments are still subject to never-ending market ups and downs. But when compared with individual stock holdings, the lows won’t be as low and the highs won’t be as high. And most importantly, if you play the odds and assume you are not part of the 20% who consistently outperforms Indexes, well, you’ll probably sleep better at night while making a whole lot more dough tucking your earnings into Index Fund investments.
Author Bio: BuddhaMoneyLama is the pen name of a financial blogger who founded www.buddhamoney.com. The blog guides readers to becoming wealthy through the usual ways (more saving, less spending, less debt = more money) and through finding balance in life.