Before you invest, says John Schneider of Debt Free Guys, learn the ropes first and develop a plan.
Do you have that drunk uncle who every Thanksgiving espouses his knowledge of investing? You know—the one who knows the hottest stock each year, yet he barely has two nickels to rub together? Do you also have a second cousin-in-law you’ve never met, who got rich day trading in the 90s?
We all do. On the surface, it can seem like professional investors effortlessly make bank by day trading on their iPhone, while non-professionals can’t beat inflation in their 401k. But look more closely at the pros at work, and you’ll find strategies to emulate.
My husband David and I have more than 31 years’ combined experience in financial services. We’ve both been traders. I’ve supervised other broker’s investments; David has built trading software and systems.
From that experience, we’ve noticed patterns that we believe distinguish professional investors from hobbyists—and believe the pros fare better. Here are five pro practices to try.
Have an Investment Philosophy
What’s your investment philosophy? If you don’t have one, it’s time to figure it out.
Think of an investment philosophy like a mission statement, covering your beliefs on:
- Are markets efficient or inefficient?
- Do investors behave rationally or irrationally?
- Do taxes devalue investing or have a negligible effect?
- Are you tolerant of risk, or are you risk averse?
- Will you use index funds, and if not, what will be the foundation of your portfolio?
It’s this clarity that guides professional investors through good and bad markets. Markets go up and down; good investments come and go; politics change. An investment philosophy is static.
Have an Entrance and Exit Strategy
Non-professional investors too often let emotions dictate their investing behavior. This is never more apparent than during down markets, especially rapidly declining ones like the 2008 housing bubble burst and this year’s Brexit.
While it made sense to exit the market as soon as the housing bubble burst, Brexit was merely a blip on U.S. markets. All the same, many non-professional investors wanted to exit both markets. That’s where an exit strategy comes in.
What are entrance and exit strategies?
Glad you asked! Entrance and exit strategies are predetermined prices, based on an investment philosophy, at which professional investors buy and sell investments. They remove emotions from investment buy and sell decisions. (Remember, emotions hinder investors in achieving long-term investing goals.)
Speaking of goals…
Have Investment Goals
Investment goals, like S.M.A.R.T. goals, are Specific, Measurable, Actionable, Realistic, and Time-Bound.
Investment goals provide clarity as to why an investor invests: for example, “to save $1 million by age 65 and retire with my current living standard” or “to grow my daughter’s 529 Plan account to $300,000 by the time she’s 18.”
In both examples, the goal is clear and “specific.” They’re “measurable”—it’s easy to track investment and portfolio performances. They’re “actionable”—investors can buy and sell investments as necessary.
Being unrealistic isn’t an option. It will only set you up for failure. (Your advisor can help determine feasibility.)
Finally, both goals are time-bound—each states an age as a goal for reaching the desired potential.
Manage Your Investments to Your Risk Tolerance
We all have our own risk tolerance. What seems smart to some is foolish to others. I recently quit my day job to turn my side-hustle into my hustle. Based on everything I know and feel, this is the right decision for me. My parents, on the other hand, are having sleepless nights.
So it is with investing. Professional investors are like Goldilocks: They’re not too conservative or aggressive; they invest “just right” based on their risk tolerance. They avoid sleepless nights that lead to poor investment decisions the next day.
The most common mistake we believe uninformed investors make is not diversifying. When I sat on the trading desk of a full-service brokerage firm, I fielded hundreds of calls from people asking to put all their money in one stock or another. This often happens when someone famous mentions a stock.
Remember when Howard Stern joined Sirius? People who never heard of satellite radio before suddenly wanted to put every dollar they ever saved into the company. The initial price increase didn’t live up to the hype—and neither did their short- or long-term gains.
Invest Like a Pro
I don’t actively invest like a professional. I invest my portfolio in a wrap account, and pay my financial advisor an annual fee to manage my portfolio on my behalf, based on the above rules.
Because my fee is annual and not per transaction, I don’t risk having my financial advisor make decisions based on transaction fees. We both win when my portfolio grows, so we have the same goals.
Speak with a financial advisor to learn more about investing strategies that fit your philosophy, and consider using our five rules of investing like a professional.
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While Society of Grownups hopes the information is useful, it’s only intended to provide general education. It’s not legal, tax, or investment advice, and may not apply or be useful to your specific financial situation. If you need recommendations geared to your personal financial situation, schedule time with a financial planner. All investing has risk, including the loss of all capital.