Are you a smart investor?
Written by Rick Welch
(smärt) adj. 1. keen, clever or shrewd. Also, bright, intelligent, savvy and perceptive.
A smart investor exhibits all of the above qualities. He or she is also deliberate, careful, informed and disciplined. A smart investor knows that good investing occurs over years and business cycles, not from one quarter to the next. A smart investor is patient, willing to devote hours to research and study, executes trades without emotion and understands that sometimes the best action is to take no action at all. There are no shortcuts to be considered and the investing fad of the day is of no interest. If you would like to improve your abilities as an investor, you should consider following these guidelines:
- Asset Allocation = Peace of Mind – Over the long term your mix of stocks and bonds will have a far greater impact on portfolio performance than individual security selection. Understand that risk tolerance (how much investment risk you are willing to take) sets the foundation for your portfolio in that it suggests your ideal asset allocation – the best mix of stocks, bonds and cash. A simple rule is to subtract your age from 100 and your answer would be the percentage of stocks held in your portfolio. This is overly simplistic, but it demonstrates the point that for most investors, age and stock allocation percentage within our portfolios are inversely related. The shorter our investing time horizon (when we need our money), the less risk we should be willing to take in our portfolios.
- Diversification Works – With a goal of producing higher risk-adjusted investment returns, we must diversify broadly across many asset classes and categories. To construct a well-diversified portfolio, you must understand correlation which is a measure of how prices of two different securities move in relation to each other. As you develop an investment plan, focus on getting size (large, mid or small cap), sector and region/country right. A broad approach to asset selection allows for adjustment of the composition of the portfolio over time, increasing exposure to those assets most likely to outperform in prevailing market conditions.
- Costs and Fees Matter – In the process of security selection, watch fees and trading costs carefully. Be efficient in every transaction and you will be rewarded over time. Many mutual funds have a sales load charge incurred at the time of purchase, time of sale or a combination of both. Avoid those that charge sales loads in favor of no-loads. Consider only funds with low operating expenses. In many cases, we prefer ETFs over mutual funds for their ease of trading, transparency and lower cost. ETF expense ratios, which often range from just 0.05% to 0.50%, are much lower than the cost of most mutual funds which typically charge 0.75%, 1.0% or even 1.5%.
- View Market Volatility as an Opportunity – Long term investors know that market selloffs or corrections are just part of the ebb and flow of the financial markets. While most volatility does not lead to permanent loss of capital it can be unnerving to the investor and impact our ability to accurately predict the expected return of an individual stock or portfolio of risky assets. The trade-off here is that with higher volatility often comes the potential for larger share price gains. In the short term, while the wider range of investment outcomes presents a challenge to investors, in the long term those same challenges must be viewed as an opportunity.
- Active or Passive – Why choose? While it is clear that active and passive strategies are both legitimate and fundamentally sound techniques, our work has shown that asset selection models that blend both passive and active strategies will generally outperform strategies that focus on one or the other. The marriage of both styles allows for the best security and fund selection decisions to be made with a keen focus on costs and fees being maintained.