Three Don’ts of an Investment Strategy

If you read my post about investing now, I wonder how you felt once you finished reading through it. Instead of me speculating about your perception, I called a buddy of mine to get some constructive feedback. As it turns out his comment was that he felt the post was too bossy. Well, crap! that was not what I was expecting to hear. He did; however, said the information and the numbers supported the case for starting to invest earlier.

As soon as he said that I developed a sense of relief but he then continued… “Ok, I get it, we need to start now, but for somebody that has no clue about where to begin what should they do? Furthermore, how should they go about setting a robust and sustainable investment strategy that minimizes the chance of making costly mistakes? … you probably made a few so why don’t you talk about them?”

The answer to this question might not be straightforward or maybe it is. In my case, my list of mistakes is quite large so I thought about whether I could consolidate it based on key themes. Before we get into that, the one thing I will say is you need to remember that the investment decisions you make depend on how much you know about the choices you have today, what you hope to achieve by investing and how much risk you can tolerate. If you make those decisions as part of a well-thought-out strategy for reaching specific financial goals you’ll have a better chance of ending up where you want to be financially.

Increasing your chance of success

Your chance of success will be heavily influenced by two opposing pieces of advice:

  • Stay the course: this means keeping a long-term perspective and continuing to invest even when you see your balance dropping because of markets decline. If you can’t stomach seeing your portfolio moving down and struggle to see the opportunity of buying at a bargain, then you shouldn’t be investing in the stock market in the first place. Think about the following quote by Warren Buffet and let it guide you through the roller coaster of emotions that come with investing.

Be fearful when others are greedy and to be greedy only when others are fearful

  • Stay flexible: this means not getting locked into choices that don’t perform as you’d expect and revising your strategy to take advantage of market conditions. Being flexible doesn’t mean timing the market which in itself is a terrible idea but what it does mean is making sure that your strategy is always in sync with your personal and financial goals.

Dont’s in my own Investment Strategy

As I reflect about my own investment strategy, I thought it would be a good idea to share what I consider the key don’ts to avoid when getting started:

1) Don’t waste your time picking individual stocks

Think about Las Vegas … just saying the name of the city sounds sexy, doesn’t it?. What’s even sexier is the idea about gambling and hitting a jackpot playing the first game you come across. Having that mindset is your first mistake. The second is lying to yourself and believing the odds are in your favor. A third one might be self-denial. It’s funny but I have friends that go to Las Vegas and they always brag about how much money they made but never how much they lost. I’m almost 100% sure once they do the math, the answer won’t be pretty.

When it comes to buying individual stocks for some reason it feels the same way to some folks. There are investment advisors out there and their job is to spend hours, days, months and years doing research and analyzing companies in hopes of beating the market. Yeah, they might be able to do it year 1, 2 or even 3 but history has shown that these guys who we tend to refer to as “experts” end up underperforming the market in the long run. If this is the case why bother investing in individual stocks? The only thing I can think of is that, just as Las Vegas, there’s a thrill around the idea of betting on a winner so that we earn bragging rights. In addition, it’s just sexier than talking about a boring investing strategy focused on passively managed index funds.

When I got started, the idea of “gambling” with individual stocks sounded appealing to me. Allegedly, many of my co-workers and relatives were making a killing so I thought to myself if they can do it so can I….. wrong!. A lot of people follow the same train of thought; however, when it comes to investing in individual stocks, and being successful at it, only one name comes to mind … Warren Buffet. This guy is definitely an outlier and if you believe you’ll be able to mimic what he has been able to accomplish then you’re dead wrong.

Despite this, I opened an account last year at Robinhood which I still have today. I have less than 3% of my portfolio in around 11 stocks that have performed relatively well at 17% from its opening date back in June of 2016; however, if you track the S&P 500 you’ll see it has returned ~16% for the same timeframe. So why bother? at this point, I’m thinking about keeping my portfolio as is and perhaps selling some positions so that I can park that money in index funds where the core of my portfolio is located at.

Picking individual stocks, in my opinion, is rarely a winning strategy for the average investor. In fact, it’s no strategy at all. Instead, keep it simple by investing in well-diversified passively managed index funds.

2) Don’t time the market

According to Wikipedia Market timing is “the strategy of making buy or sell decisions of financial assets (often stocks) by attempting to predict future market price movements. The prediction may be based on an outlook of the market or economic conditions resulting from technical or fundamental analysis. This is an investment strategy based on the outlook for an aggregate market, rather than for a particular financial asset”.

In short, we are talking about predicting when you’re going to be at a peak so that you can sell and when shit has hit the fan so that you buy at a low point.

Some investors, in particular, active traders, believe they can accurately predict the future direction of the stock market using timing algorithms; however, investors who try to time the market, especially mutual fund investors, tend to underperform investors who remain invested. Think about it, how consistent and successful can you be selling at a high and buying at a low in the long-run? I personally don’t have the time or desire to watch the market on a daily basis so I just focus on my boring buy and hold strategy where I continue to invest using Dollar Cost Averaging or DCA.

By using this approach, I invest a fixed amount of money at a given frequency (normally bi-weekly because it’s in sync with my paycheck) regardless of stock market conditions. The theory is that in some cases you’ll buy both at a premium and at a low point. As a result, you’ll get fewer shares when prices are higher and will get more when prices drop. There are pros and cons with DCA and studies actually suggest that lump-sum investing might be a better option.

When I began investing, I actually started with a lump sum without knowing if I was buying at a high or a low. As it turns out, I bought at what some would consider a peak. This was followed by a low point that hit my stomach pretty hard. I then read about DCA and thought I had made a rookie mistake. Luckily, I decided to suck it up and stick to my plan which was to also set automated deductions so that I could keep investing. I guess you could say I was using a hybrid model that started with lump sum investing followed by DCA.

Whether you want to do DCA, lump sum investing or a hybrid, don’t your waste time thinking you know more than you actually do. Unless you have a crystal ball, just be aware of your risk tolerance and pick a strategy that works for you.

3) Don’t let your emotions get the best of you

In my few years as an investor, I’ve made some dumb moves that have brought painful, yet valuable lessons learned on how to improve my strategy. However, the one thing I’ve never experienced is panicking when in presence of market moves. For some reason (still, haven’t figured it out), I remain insensitive to this type of emotion.

Don’t ask me why but that’s just the way it is. I can still remember opening my Betterment account back in 2015 and losing around $7K in a matter of months because I just happened to make my contribution when the market was high … remember market timing?.

I wasn’t celebrating being down; however, I kept telling myself … “you haven’t lost any money is just the shares you bought have dropped in price”. Some of the podcasts I had listened to, kind of helped me stayed the course and as result, I actually kept buying more during this semi-bear market. History has shown that as long as you have discipline and stick to your plan (assuming is a well-thought out one based on your goals) you’ll be fine. Today, I’m happy to say the negative numbers have turned positive and the numbers look good!.

I guess my message is not to let your emotions get the best of you. If you panic and you sell while the market is down then at this point you’ll be realizing a true loss. If you’re thinking you may want to get out to avoid further losses, think about what you’re going to do with that money. Also, remember that the market is very volatile and you probably will miss periods of greatest price gains.

Final Thoughts

  • Once you develop an investment strategy to meet your financial goals stick to it and be disciplined to stay the course.
  • Forget about picking individual stocks and think about passively managed low-cost index funds.
  • Even if you make me happy going into passively managed index funds, forget about market timing and start investing now.
  • Don’t let your emotions get in the way of reaching your goals.

Leave a Reply

Your email address will not be published. Required fields are marked *