Some things are simple in concept, but not easy in execution. Investing is one of them.
So, why is doing it so hard? Today we’ll cover:
What makes investing simple, but not easy;
the challenges of different types of investing;
tips to help make you a better investor; and
the single most important key to investing for retirement.
First, let’s talk about the most basic reason why more successful investing is simple, but not easy. The fact is most humans simply aren’t wired to be good investors. We may consider our choices logically, but in the end, we make decisions emotionally – especially financial decisions. As a result, most people tend to invest through the rearview mirror – or to put it in clinical terms, with “hindsight bias”. The simplest example goes like this: The stock market is hitting record highs, so that’s when you decide to get in. However, at that point you’ve missed out on most of the gains and entered the market closer to the next drop. The objective you were seeking – growth – is already in the rearview mirror.
On the flipside, when the market starts to slide, you stay put. You remember that simple principle called “buy and hold”, so you hold. But the market keeps sliding, and at a certain point you throw in the towel and get out. Once again, your objective – to help protect yourself from a big loss – is already in the rearview mirror. Naturally, this is an exaggerated example, but it does illustrate the psychological challenge at the heart of investing. Remember, most people are wired to make decisions emotionally.
In fact, most financial decisions are driven by two powerful emotions: fear and greed. By greed I mean the natural desire to get as much as you can when you see the opportunity, to make hay while the sun shines. When the markets are soaring it’s like the sun is beaming, so that’s when greed kicks in. Fear works the same way when the markets are falling. First, you’re afraid to sell too soon, then you’re afraid not to sell once you’ve already lost a big chunk of your savings. Ultimately, this explains why the markets themselves are driven more by emotion than by economics.
Now, let’s talk about some other challenges.
When I talk about the markets being driven by emotion, I’m not just referring to the stock market. Although things tend to change less quickly or dramatically in the bond market than they do the stock market, the changes are still driven largely by greed and fear. In fact, they are usually closely linked to emotional shifts in the stock market.
Another issue that makes bond investing simple, but not easy, has to do with the well-known principle that when interest rates go down, bond values go up, and vice-versa. As I’ve explained before, it’s not that straightforward because many other factors besides interest rates can affect bond values. Plus, with many bond-based strategies, the fluctuating value of your investment is largely irrelevant because its face value doesn’t change if you hold the bond to maturity.
However, that’s not as easy as it sounds either, because you need to find bonds with good, competitive return rates and little risk of default. That means knowing just what to look for in the companies selling bonds. In my experience, doing that successfully takes professional knowledge. The same holds true with another stock market strategy, which is investing for dividend income rather than capital gains. There’s a misconception that investing for dividends is easier than investing for growth, but the fact is, the opposite is true. Dividend investors need to ride a knife’s edge between determining which dividend-paying companies are true values and which ones are value traps. That’s neither simple nor easy, even for professionals.
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So far, we’ve covered the psychology of investing and looked at some other factors that make different types of investing so challenging. Now, I want to share some tips to help you tackle some of these challenges, but before I do that, let me make two points:
First, no tip I can give you will make more successful investing easy but keeping these principles in mind can help improve your odds of success. Secondly, these guidelines should be used as you work in tandem with your financial advisor. They aren’t meant to encourage do-it-yourself investing. With that in mind, here we go:
Tip Number One: Be wary of jumping into fads. This can be tough when some hot new stock or strategy is making headlines and your friends are urging you to hop on the bandwagon. However, fads come and go, and most are speculative and risky.
Tip Number Two: Get cautious when others are getting greedy. In other words, be a contrarian. It’s natural to want to make hay while the sun is shining, but a peaking market can actually be a good time to reduce your risk and move some assets into safer strategies – to sell high, like you’re supposed to. If the market does drop, you then have the opportunity to buy low, like you’re supposed to. Which leads to the third tip:
Get greedy when others are getting fearful. Emotionally, a down market can seem scary, but financially it can be a great buying opportunity.
Lastly, tip number four: Diversify. Putting all your eggs in one basket is never a smart idea. When investing for income, a well-diversified, actively managed portfolio can help ensure you’re always achieving the most common investment objective: maximum return with minimum risk.
Now let’s talk about the single most important key to successful investing:
Know why you’re investing. That sounds obvious, but it’s amazing how many people invest with vague objectives like “to make a killing in the stock market” or “to save enough for retirement.”
Knowing why you’re investing means going deeper than that by identifying your specific retirement goals. When you know exactly why you’re investing and what you’re investing for, you’re less likely to make some of the mistakes that make the process so hard. That’s because you’ll be able to create a financial strategy geared directly toward your goals. In my experience, those goals are similar for most people. They’re not really interested in making a killing. They’re not looking for maximum portfolio growth so they can brag about it. That’s not why they’re investing.
They’re investing so they can enjoy their retirement with more reliable income and peace of mind, income that maintains their quality of life and lets them do the things enjoy. All of that comes down to just one word: income. For most people, once they realize the reason they’re investing is to help make sure they have sufficient and reliable income, they quickly realize something else: that a financial strategy geared directly toward income makes sense. It’s logical, and a sound, rational strategy tailored to your goals can be the key to overcoming all the many challenges that make investing simple but not easy.
Math makes sense; emotions often don’t. Fear and greed are protective primal instincts, but they can also be dangerous. That’s true in every aspect of life, including investing. However, the mental and emotional challenges of investing are only a small portion of what make the process simple, but not easy. Different types of investing have their own highly complex technical challenges as well. In the end, there’s nothing you can really do to make more successful investing easier, but you can greatly increase your odds of success by identifying your individual retirement goals and working with the right advisor to help achieve them. It all starts there.
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