Over the course of my 35 years as a trader, portfolio manager, and personal investing coach, I've worked with thousands of investors. I've trained them, advised them, and coached them. I've observed a few common traits that investors share, which allows me to categorize them into different investor types. What follows is a summary of these types, along with a description of their common characteristics.
Ad Hoc Stock/Fund Pickers
These are people who operate by the seat-of-the-pants. They have no plan, no strategy, and no skills. They can go for months or years without opening a brokerage statement to see how they're doing. Then suddenly, they hear a friend or associate bragging about making a killing in Acme Biotech. So they spend an hour-and-a-half googling Acme Biotech and a few other companies they've heard about, and they invest some of that pile of cash that's been accumulating in a money market account, earning 0.1%.
For the next couple of months, they open their account statement to find out how they're doing. They might even check the prices online every few days, especially if the market is going up. But eventually, they lose interest, and they return back to their regular routine.
These are people who don't really have a plan, but they think they have a great strategy. They go online and find one of the many mutual fund or ETF screeners, and sort the list by the best past performers. Their reasoning goes like this. If this fund manager beat 95% of his peers over the last 5 years, he or she must be really smart. I'm going to bet on a winner, and make lots of money.
Unfortunately, the evidence is overwhelming that past winners don't stay at the top of the performance charts for very long. By the time a clear winning streak gets noticed, and tons of money pours into the fund, the hot streak is already starting to cool off.
So, after a year or two of disappointing returns, the chaser bails out and begins the process all over again. The strategy turns out to be "buy high and sell low."
These are people who are at the very top of the overconfidence scale. They know nothing, but they think they do because they paid $4,000 to attend a day trading seminar. They were told, over and over again, that they can and will beat the market. They are constantly brainwashed by Wall Street, CNBC, financial advisors, discount brokers, gold hucksters, YouTube channels, etc. After all the media bombardment, and reading Elliott Wave chart patterns, these poor souls have convinced themselves that they are part of an elite brotherhood who have figured out what to do.
They are delusional. They've made the fatal mistake of thinking that a guy at home in his pajamas can consistently make profits and compete with professionals at major Investment Banks, High-Frequency Trading firms, and Hedge Funds. They don't grasp the idea that the traders they're competing against in the market have multi-million dollar IT systems, fault-tolerant networks, dedicated lines to the stock exchanges, advanced trading algorithms, internal dark pools, deep industry connections, etc.
There is a near-zero chance that in the long run anyone will be able to day trade in a consistently profitable manner. Once day traders go broke they set up a YouTube channel to promote their "great" trading system, and a new crop of day traders is born.
These are investors who know nothing, and they know that they know nothing, but they have decided to play the market anyway. Like weekend gamblers in Vegas, they're in it for the thrill, the excitement, and the entertainment value. They pick stocks based on random investment recommendations that they stumble across on the internet. They are lazy, and they think they can free-ride on tips from Wall Street experts, financial bloggers, or a bald guy with sound effects on CNBC.
Followers of Market Gurus
These are people who blindly follow the advice of high-profile market sages. There are outstanding investors such as Ray Dalio and Warren Buffett, but what they do has little relevance to what a retail investor can do. It is a mistake to think that you can replicate what Buffett or Dalio have accomplished.
Hedge Funds and Prop Traders
These are the masters of the universe who make millions of dollars a year. They eventually run into trouble when they get too big, and they can no longer operate under the radar. Once other, younger traders figure out what they're doing, they replicate it and erase whatever the edge was.
These are people who have several advantages over most other investors. Number one, they actually enjoy the hard work that goes into developing a winning investment strategy. They are usually quick with numbers, but they aren't math geniuses. They are humble, which keeps them from falling into the trap of overconfidence. Humility also allows them to recognize a mistake early, and get out of bad positions before they turn into disasters.
They have above average critical thinking skills. They look at potential investments from various angles, and ask themselves questions like "what could go wrong" and "what has to happen in order for this company or fund to thrive?"
They usually have a friend or a mentor who they can bounce their ideas off of, to get an outside opinion about the viability of their investment thesis. And they have good situational awareness, which means they pay attention to what's happening in the economy, what the trends are in the industry, and what geopolitical risks might threaten their investment assumptions.
There are roughly 100 million individual investors operating in the market today. The winners are those who capitalize on the mistakes that the losers make. It doesn't take a genius I.Q. or an advanced degree from M.I.T. to be a successful investor. All it takes is a reasonable amount of effort up front, to lay out a plan that includes your strategy, your trading rules, and your behavior checklists. You don't have to trade very often.
Rebalancing once per year is plenty. Some of the best investors I've known have simple portfolios that contain 4 or 5 well-chosen ETFs or mutual funds. They're well-diversified, but not over-diversified. If they have high conviction for an idea, they aren't afraid to bet big. And they have a clearly defined sell discipline that keeps them out of major trouble. These are the investors that I most enjoy working with.