Being a successful investor requires two things most people are not very good at: discipline and patience. Sure, it’s possible to make a quick buck in the market and feel like you know what you’re doing, but that’s as much a matter of luck as winning big in Las Vegas.
And as in Vegas, it’s just as likely, probably even more so, with that kind of behavior to lose your entire stake. Successful investors approach the markets with a plan in mind and take disciplined steps over years to execute that plan to success.
Over the hundred years that we’ve been investing as a firm, we have found five tenets that separate winning investors from their losing counterparts:
1. Buy Stocks for the Long Term
Investing should be approached as a long-term proposition. Markets are cyclical and not even the best stock pickers know which will be the up or down years. Over time, equities have been shown to outperform bonds and cash and provide some protection against inflation, but they are more volatile year-to-year than those other two asset classes. Nevertheless, the value of the S&P 500 has grown in 39 of the last 50 years and offered an annualized return of 10.3%.
A JP Morgan analysis showed that an investment of $10,000 made at the start of 2003, if left untouched for the next 20 years would have grown to $64,844 even though those years included times of market upheaval like 2008, when the S&P 500 lost about 37% of its value, and the pandemic panic when the current turmoil began, and the market sunk into a bear market in 2022. Investors who stuck with equities through all that volatility have been big winners.
2. Diversification Matters
The returns from any single asset class can vary substantially from year-to-year, creating a need for exposure to multiple asset classes at any given time. A diversified portfolio should contain a varied selection of asset classes.
It’s important to keep in mind that investing necessarily entails some degree of risk but having a widely diversified portfolio helps to tamper that risk by containing a variety of elements whose performance is not correlated to each other. Historically, portfolios containing a variety of asset classes have been shown to deliver higher long-term returns than more concentrated portfolios.
Of course, diversification can also inhibit performance during times when a particular asset class is dramatically outperforming the rest of the market. But since prudent investing takes a long-term view, times like these are when it becomes even more important to stick to Tenet #3.
3. Success Comes from Sticking to Your Strategy
Consistent exposure to the markets is a key to long-term investment success. The biggest mistake that an investor can make is selling in a panic when the market starts to fall and then trying to time their re-entry. Spoiler alert: this never works.
A recent analysis found that the 10 best stock market days over the last 20 years came on the heels of big drops during the 2008 financial crisis and the early days of the Covid-19 pandemic. Investors who cashed out when the numbers fell missed out on those big gains a few days later to the long-term detriment of their portfolios.
Missing out on the days when there are significant gains makes it that much harder to bounce back from the loss that inspired the sell-off. Quite simply, trying to time when to get in and out of the markets is a losing proposition.
Doing nothing in times of market stress is highly emotionally unsatisfying, but it is almost always the best thing you can do. Just look at the facts: the market has a 100% track record of not only recovering all losses but reaching new highs as well. 100%. You just have to stay in the market.
4. Mix Active & Passive Strategies
Hand-in-hand with diversification of assets is diversification of strategies, with a thoughtful mix of active and passive strategies tending to produce better results over the long term due to the cyclical nature of markets. Choosing a blend of active and passive managers within your portfolio can help capture positive returns while reducing risk and expenses. There are upsides and downsides to each approach, which is why a mix of the two is usually the best approach.
Active investment managers are just that, active. They pay constant attention to the markets looking to capitalize on every opportunity. They also tend to be more active traders and trades cost money, so their expenses will be considerably higher than a more passive manager.
Passive investing is more the traditional buy-and-hold approach and is most easily accomplished through buying shares in index funds or ETFs, which typically follow a benchmark index. It’s also easy for the investor to know what they own since the components of the fund mirror those of the index they track. And there tend to be fewer short-term capital gains taxes.
On the downside, passive funds are limited to the companies in the index they track, and they’ll never outperform the market, because they are the market.
Active managers have much more flexibility which affords them opportunities to discover up-and-coming and still undervalued stocks with growth potential. In some cases, they can also employ various hedging strategies to help reduce risk.
5. Be Tax Sensitive
When it comes to wealth it’s not what you make, but what you keep that matters. In order to maximize the benefits of your investment strategy, you need to be cognizant of the tax implications of any tactics that you utilize, above and beyond your standard tax planning and compliance.
Working with a professional advisor can help investors minimize their tax bills through such techniques as tax loss harvesting, wash-sale management, and short-term gain deferral. Putting these kinds of tools to work at the end of the year typically enhances portfolio performance by around 100 basis points annually. But managing tax liabilities and capital gains isn’t something you should only think about in December. It’s something you should do all year.
Philanthropy is another way that you can reduce your tax burden if you’d rather give your money to the charity of your choice than to Uncle Sam. The tax code allows taxpayers to deduct charitable contributions up to 50% of their adjusted gross income for cash donations. Donating appreciated stock is a great way to sidestep capital gains taxes, although the non-cash donations are limited to 30% of the taxpayer’s adjusted gross income.
Investment success is never guaranteed but sticking to these five basic tenets can go a long way toward helping you achieve your long-term financial goals.
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