Investors too often lose money by worrying too much about investment products, rather than directing their attention to the process of investing.
Far too many people fall into the trap of watching the latest Wall Street headlines on TV or in newspapers, magazines, and online publications, and then trying to chase returns.
These investors are seduced by media headlines such as: “Experts Predict The Hottest Stocks of 2012” or “The Best Mutual Funds to Buy in the New Year.”
This is precisely the wrong way to go about investing. Investing should not be about chasing down individual products, but about how you can best manage the process of investing.
In my view, investing entails five phases.
Phase 1 involves strategizing to meet your own personal goals and needs.
In other words, before you ever buy a single investment, no matter what it is (a stock, a bond, a commodity, a real estate investment, a mutual fund, or something else), you should make sure that that investment fits into your overall financial objectives and your overall investment portfolio.
It should also be risk appropriate for you. And above all, your strategy should incorporate a proper asset-allocation model. Studies show that 90% of your portfolio’s performance is based on your asset allocation – or the mix of stocks, bonds, cash and other investments you hold.
On the other hand, buying investments willy‑nilly just because somebody else bought it or just because the price might be increasing or decreasing, or just because you might have heard about it on CNBC or elsewhere, is a quick way to lose money fast.
Phase 2 is about buying investments for the right reason at the right time.
The buying phase of the investment process is the one that most investors typically focus on, but they do so in a haphazard way or in a way that doesn’t make sense economically. Too many people buy based on lists. Too many people buy based on popularity.
And too many people buy investments, frankly, that they don’t even fully understand or haven’t carefully vetted.
If you’re going to buy an investment, at the very least you should understand the company’s business model, the inherent risks in the industry in which the company operates, as well as the risk that you might lose of your principal or your investment. You should also buy an investment for the right reasons (i.e. reasons that link back to your goals as outlined in Phase 1).
Sometimes people buy simply because they’ve heard that they should own small cap stocks or large cap stocks. Well, you might load up your portfolio with one fund or another and not realize you’re duplicating investments or you’re buying something that doesn’t fit with your long‑term criteria.
Phase 3 of the investing process involves holding and monitoring the assets in your investment portfolio.
It’s not enough to set it and forget it when it comes to your investments. You can’t just put things on autopilot and expect that they will run efficiently and operate functionally and well for you forever. The investing world simply doesn’t work that way.
You should be monitoring your investments at routine intervals, making sure you don’t have portfolio overlap, making sure that your asset allocation doesn’t go awry, and making sure that something that made sense for you six months or six years ago when you bought it still does, in fact, make sense today.
The monitoring phase is also a critical element of successful investing, but it doesn’t require day-to-day obsession over your investment portfolio. Regularly, systematic checkups are fine.
Phase 4 of the investing process is all about selling.
The key here is for you to sell an investment for the right reason, at the right time, and in a tax‑efficient way, Thus, your selling should be done in a judicious manner, not as a knee-jerk reaction to something.
You don’t want to sell during a panic when the market is tanking and you’re just trying to bail out as hundreds of thousands if not millions of other investors are dumping a stock or an investment.
Neither do you want to sell prematurely because you’re fearful that a stock or an investment that you chose has had an unbelievable run‑up and “can’t possibly” have any further price appreciation.
You need to develop a disciplined sell strategy, something that’s so important, yet so undervalued and frequently not attended to by most investors. The ideal time to determine a sell strategy is when you buy an investment. Right up front, you should have a benchmark to know under what circumstances, and at what time or under what conditions you will sell.
For example, if the stock you buy climbs 20% in a year, will you sell? If it falls 20% in a given time period, say in a year or less, will you sell? Sometimes it’s helpful to put stop‑loss triggers in place to help you to deal with downside risk and the chance of your investments going sour.
Phase 5, the final phase of the investing process, is dealing with financial advisors and financial intermediaries.
Unfortunately, you can do all of the first four phases of the investing process right. You can strategize well, buy right for the right reasons, properly hold and monitor the assets in your portfolio, and even have a wise selling strategy. But if you miss or neglect to handle the fifth phase, dealing with financial advisors, you can certainly get burned.
We’ve all heard of the Bernie Madoff scandal and, indeed, an ongoing slew of other scandals involving financial advisors, accountants, CPAs, money managers, hedge fund executives, traders, and others who have scammed or allegedly scammed their clients.
The challenge for you as an investor, of course, is to not only avoid those unscrupulous financial individuals, but also to make sure that you work effectively with the legitimate financial advisors that you do choose.
You don’t want to be a pain in the butt client, as I call them, and as some financial advisors have told me in private that they label some of their clients who are unreasonable in their demands or expectations.
But neither do you want to be an absentee client who rarely, if ever, checks in with his or her financial advisor, and who really doesn’t get a lot of value added out of the advisor.
One of the keys successful investing is to make sure that you are a good client and that you’re getting good service from a good advisor.
Therefore, if you want to see better investment returns in the future, try focusing on the 5-phase investing process, and stop worrying about individual products you might buy.
If you do it this way, I can tell you with certainty that you will become a much more successful investor.
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