Investing is easy. Anyone with a few hundred bucks and a broadband connection can do it. Just go to www.[etrade, schwab, fidelity, scottrade, etc.], fill out an account application, send them your money, pick a couple of stocks that will go up and boom, you're an investor!
So what's the big deal? If you were paying attention, you probably noticed a little glitch in this procedure. How do you know which stocks (out of a universe of 10,000 or so) are going to go up? Well, you'll probably have to do some homework on that part. In this series of articles, I'll show you what it takes to master the art and science of investing. I'll do that by showing you the critical decision-making steps that highly successful investors go through.
Who are these highly successful investors? They're the big money players. The institutions which handle the pensions, endowments, and foundations that control most of the money and almost all of the action in the markets. These players behave in remarkably similar ways, because they have learned how to use proven strategies for success in investing. Amateurs tend to invest by the seat of their pants, jumping from one get-rich-quick scheme to another in an endless and naive attempt to beat the market.
If you are willing to spend just a little time and energy to learn how to make these four critical investment decisions correctly, you can create a simple but powerful investment portfolio that will rival the biggest and most powerful professionals out there today.
By far, the biggest shortcoming for most investors is a failure to spend enough time planning. Studies have shown that investors who do even a minimal amount of planning get results that are twice as good as investors who don't plan at all. And investors who put a lot of effort into planning, and who regularly monitor and adjust their plans, get results that are three times better than non-planning investors.
Here are the four key decisions you have to get right:
- Decision #1: Should I go it alone, or hire a professional to help me?
- Decision #2: Should I be an Active or a Passive investor?
- Decision #3: How should I divide my money among different investment choices?
- Decision #4: Should I be out of the stock market right now, or should I be in?
Today, I'll explore the first decision you'll have to make: whether or not you should hire a professional to help you set up your investment strategy. This decision should not be taken lightly. Getting it right is going to take a little time and effort on your part. Even though I'm a professional who benefits from selling my advice and expertise, I have to admit that there are some people who have the ability to go it alone, and make a success of it. It's just that there are very few amateurs who truly qualify. How few? Based on the most recent studies I've seen, roughly 5% of all self-directed accounts that are tracked by firms like Schwab, Vanguard, and Fidelity, match or exceed the returns of the stock market in general as measured by the Vanguard Total Stock Market Index.
What this means is that investors who choose to go it alone, do their own research and pick their own stocks and funds, have a 95% failure rate. If you believe that you are smarter and more disciplined than 95% of your peers, then by all means go ahead and do it yourself. But here's the question I have… why? Why would you willingly participate in a game where the odds are stacked against you so much?
So what does it take to qualify for membership in the 5% club of successful do-it-yourself amateur investors? It takes a lot. These rare, successful amateurs are motivated, organized, and disciplined. They have a plan, a strategy, and a clearly-defined process for every investment decision they make. Do you think you have what it takes to become a member of this exclusive club? Here's a list of the skills, resources, and temperament that all successful investors have in common. They are:
Available. Do it yourself investing takes time. How much time do you have available for this task? You can't do it well unless you are in a position to devote serious time to it. Weekend Warriors are the worst. They think that spending a couple of hours on a Saturday afternoon will be enough to qualify them to compete against professionals who spend eight hours every day on investing.
Interested. Many do it yourselfers start out with a bang, but quickly tire of the monotony of keeping up with the market. Unless you're genuinely interested in pursuing this on an ongoing basis, you're better off paying someone else for advice.
Motivated. Always remember that investing is a competition. But you're not competing against 'the market' or some monolithic entity that can be outmaneuvered. You're competing against highly skilled, well-compensated pros who will eat your lunch at the first sign of weakness or disinterest you may show.
Organized. The big money players all work with a plan. They spend hundreds of hours developing and honing their plans, and there's a good reason for this. Studies show that investors who plan get results that are far better and more consistent than investors who shoot from the hip.
Disciplined. Will you have the stomach to weather the downturns in the market? That takes discipline, and very few amateur investors have it. The most common pattern among amateur investors is to have a string of successful stock picks, followed by a couple of large losses. It takes discipline to handle losses correctly, and avoid getting shaken out of good stocks at the bottom of the market.
Humble. A common mistake that amateurs make is thinking that they can outsmart the market. This is possible only on a short-term basis, but not over longer periods. Professionals know that they are not smarter than the market, but they can profit by listening to what the market is telling them. Admitting you were wrong on an investment takes humility. But it will save you lots of money and aggravation in the long run.
Adaptable. Markets change and so does the economy. Investors who stubbornly stick to a strategy that is no longer working have not mastered the art of adaptability. But the real trick is knowing when to stick to your discipline, and when to admit that the market environment has changed. This is a skill that takes years of experience to learn.
If you think that you possess the skills and temperament listed above, and you have the time and interest to go it alone, then by all means do so. If not, do yourself a favor and hire an experienced coach to help you. It will probably be the best single investment you'll ever make.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.