Look at the financial magazines at the airport newsstand or turn on CNBC and you will notice that most financial news stories cover topics such as the top investments and whether or not it is a good time to buy or sell stocks. These stories make great magazine headlines and compelling television, but they have very little to do with what it takes to be a successful investor.
I’m of the opinion that most investors not only underperform the “market”, but they significantly under perform their own investments. Why? Because at the peak of a euphoric bull market just prior to a crash, investors pour money into the stock market, and after the crash but just prior to a recovery, investors panic out and retreat to the safety of CD’s and savings accounts. But this phenomenon has more to do with emotions and behavior, not investment skill or the ability to predict the direction of the market.
In other words, the key to successful investing has little to do with picking the next Microsoft, or knowing when to get in and out of the market, or identifying the next Warren Buffet – all things that are extremely difficult, or even impossible, to achieve on a consistent basis. Instead, the primary determinant of long-term investment performance is discipline.
For many investors, this realization is a liberating paradigm shift. Instead of trying to solve the unsolvable puzzle of “beating the market”, the investor can instead focus on something that is achievable – establishing and following a disciplined investment process.
One way to help become a more disciplined investor is to perform a “stress test” on your investment portfolio. To perform a stress test, simply research how your portfolio (or a portfolio with a similar mix of stocks and bonds) would have performed during a previous market crash. You can use the crash of 1972-73, the “tech crash” of 2000-2002, or the roughly 56% decline in the S&P 500 from October 2007 to March 2009. Ask yourself ‘would I be able to stick with this portfolio if (and when) this were to happen again?’ If yes, then proceed with the proposed asset mix and use the exercise as a way to mentally prepare for the next market downturn. If the answer is no, then it may be necessary to lower the percentage of equity investments in your investment portfolio.
Some investors may find it worthwhile to hire a financial advisor to assist them with their investments. An advisor can be very helpful in providing advice on a wide range of important financial planning issues, but perhaps the most important benefit an advisor can provide is investment discipline. Any advice that provides investors with discipline and helps clients avoid behavioral mistakes is likely to be the most important financial planning advice an advisor can provide.