Investors frequently make mistakes simply because they are human. Very natural and understandable feelings, like fear and desire for wealth, can cause us to behave in ways that actually harm our financial goals. Good investors, however, are able to resist the influence of emotion on their investing decisions and often can avoid these mistakes altogether. They also tend to see positive results from their investing efforts.
What success means, of course, depends on each investor's portfolio and goals. To set reasonable goals, many investors use benchmarks that are specific to their portfolio. In my opinion, an investor is successful when investment returns meet or exceed the appropriate benchmark, and investments are growing faster than the investor’s personal expenses over time.
In my role as a financial planner, I get to see a lot of investors’ portfolios. In thinking about the past 14 years of reviewing other people's investments, I’ve come to a few conclusions about what makes a good, and often successful, investor. Good investors are:
Patient investors only periodically review their investment results. They focus on diversity and cost as much as performance. Emotion can drive markets and corrections can happen fast, but just as quickly, the market can reverse direction. So they rebalance as little as possible according to a predetermined strategy and accept a range, rather than a specific number, for their asset allocation strategy. For example, stocks can make up anywhere from 70% to 79% of holdings if an average of 75% is the target. Only when there is movement outside that range should investors consider rebalancing their portfolio.
Patient investors are also savvy about taxes, placing more aggressive, long-term holdings that may experience higher returns in Roth accounts to avoid excessive tax consequences.
Good investors study a range of periodicals and online articles, blogs and forums like NerdWallet to keep up with new trends, but also remind themselves of successful investment strategies that have proven out over time. For example, a 60% stock, 40% bond asset allocation might be advised for investors with five to 10 years until retirement, but if a new article claims this strategy no longer works, a good investor would look for information and data that support or refute this opinion.
Doing this kind of additional research before getting swept up in the latest trend would mark someone as a good investor in my book.
Not succumbing to the ever-present offers to buy or sell the product of the day, a good investor asks questions to uncover risk, costs and suitability of any proposed investment. The articles they read and sensibilities they develop over time help them think through issues or risks.
Good investors focus on what they can control, knowing that they have very little control over most elements of their investments. They cannot control the markets or inflation, nor can they directly influence monetary policy or currency rates.
Instead, they focus on what they can control: Discipline, to save for the future and review their portfolio periodically; choice in tax consequences, using strategies and products that produce greater net returns; diversification of their portfolios, so that risk of dramatic losses is reduced; and expenses from investments, so that more of their returns stay in their pockets.
Measure twice, cut once
Ultimately, good investors are cautious, thoughtful and deliberate. They seriously consider their options and the potential consequences before taking action. Very often, they will seek help from a financial professional to determine how a change might add value or reduce the amount of risk in their portfolio. When making decisions, these investors use the carpenter's traditional strategy: Measure twice before cutting once.
Jim Ludwick, CFP, is the founder of MainStreet Financial Planning Inc.