Assessing One’s Investment Abilities

Some Common Misconceptions About Investing

Successful investing isn’t anywhere near as difficult or even as complicated as many people believe. The biggest misconception people hold is that doing well with your investments involves a lot of complex and detailed research into companies and the ability to sort through all the noise out there to find tomorrow’s big winners.

Assessing One's Investment AbilitiesThey may be intimidated by all the time and effort that they may see companies spending on investment research, who have large teams of people who have vastly more education and experience in investing than themselves, all dedicated full time to exploring all of the best possibilities using state of the art software and so on.

Most individual investors, on the other hand, really don’t feel that they have the means or the ability or the time to do any of this, so they just hand over all of this to the so called professionals to manage their money and make all of these decisions for them.

What people need to realize is that successfully running a mutual fund under the regulatory limitations that they are under is extremely challenging, such that about 80% of them fail to beat the market. Simply by buying an index ETF and holding it, involving no further decisions on your part, you can beat 80% of these funds as far as performance goes in other words.

There are a number of reasons why actively managing mutual funds is so challenging, and many people think or are told that if these teams of professionals with all their talent and experience and resources struggle so much in even beating the market, what chance do you have as an individual investor?

Managing mutual funds are a completely different animal from managing your own, much smaller portfolio, and there are several important differences between them. The task these funds take on is a much more difficult one to say the least, and it takes much more talent and savvy to produce better than market results.

These folks will look to analyze things in much more depth than would be required by us because they need to, in order to seek out edges within an environment that is very constrained. They have to delve into complexities in other words because of their limited tools and more challenging environments in order to seek better returns.

While we as individual investors really don’t have the means or resources or time for any of this, this good news is that none of this is really necessary to be successful or even to well outperform the results of these funds, and the skills involved are much more modest and much more in reach for us.

Trying To Act Like the Big Guys

There are two types of funds, actively managed ones and passively managed ones, index funds in other words. There’s no skill involved in passive management because you just buy and hold the components of an index, such as the S&P 500.

Due to management fees, you don’t quite replicate the index but you come pretty close, since fees with these funds are generally less than 1% a year. What the actively managed funds essentially do is choose their investments instead of just investing in all of them in an index, seeking to invest in what they believe are the better ones and not investing in ones seen as not worthy.

This is where the complications arise, as choosing investments does require a lot of effort, or at least can, where numbers are crunched and predictions are made and so on. Many individual investors think that this is where the real opportunity lies in successful stock picking for instance, and then deciding how they are going to diversify, as diversification is important as well.

So you want the right mix of stocks as well as perhaps mixing in the right type of bonds and the whole thing can quickly become overwhelming, especially with something other than a very large portfolio with the means to diversify properly.

Ideally though, we should be striving for simplicity, not complexity, and this all can become very complex if we’re not careful or if we don’t take the right approach to this task. What tends to happen often is that individual investors will approach things this way and basically take flyers on certain selected investments, without the proper knowledge and without the proper level of diversification, and most importantly, without the proper plan.

What can happen with this approach is that the decisions may not be all that sound, leading to a lack of proper risk management, even less proper risk management than the mutual funds practice, and they already are strictly handicapped with how they manage risk to start with. This all can lead to investors finding themselves in regrettable positions with little idea of how to move forward.

What we need to understand if we’re going to attempt investing on our own is that we don’t want to play the game like mutual funds have to, and for the most part the goal needs to be to look to simplify things as much as practically possible while seeking out the goals of better returns and better managed risk.

It is only when we seek to simplify that we can reasonably put ourselves in a position to do well at this task, and the first and perhaps most important step is to stay within our realm of abilities and experience and not take on too much.

Few investors, for instance, should be looking to pick their investments, as strange as this might sound. If one has a proven track record of doing so, that’s another matter, but this is more challenging to master than most people think. There is also more to this than is apparent, this is more than just assessing a company’s fundamentals, and at least most of that is already factored into its price anyway.

What we’re really looking for is to look to assess an investment’s potential by looking at the way its price tends to move relative to the market, where those that move more have both more potential and risk, and those which do not move as much will tend to have both less potential and risk. This is just the starting point though and we then must select based upon the momentum of both the asset and the broader market.

There are a lot of things to be looking at when picking investments, and this is not really an area that typical investors should even be considering delving into, although if one is truly dedicated to seeking out how to do this well there is some potential here to improve your results. Very few investors have anywhere near this level of commitment though.

Instead, there’s no reason to be selective here, as we can just invest in indexes, which reduces the amount of decision making involved significantly, and simplifying things with investing can definitely be a good thing, especially when investing casually.

Pattern Recognition is King

Successful investing really comes down to using the skill of pattern recognition and having the discipline to execute the plan. If the plan is simple enough to follow and is also fairly well devised, and is followed, then we can take what is otherwise a complex and difficult task and make it much more manageable.

The main advantage, and a rather big one, that individual investors have over mutual funds is how much more latitude and ability that they have to time their investments. Many people believe that it is either impossible or very difficult to time investments properly, but this is really not all that difficult to so in at least a way that delivers meaningful benefits over a buy and hold strategy, although the more skill you bring to the table here, the better your results will be.

This is not something you can just turn on the television or surf the web to discover, as this is going to require some thinking on your part, some analysis, to be able to spot trends and act upon them.

Markets do move in cycles though, and regardless of the time frame we look at, from minute to minute or from year to year, these trends are really not that difficult to spot, on balance that is. What this simply means is that when you are more right than wrong, you do better than random.

We see these trends in every financial instrument, where we see periods of positive momentum or negative momentum that persists. If we look at the stock market for instance, we can see several major trends over the years, and that we’re currently in an uptrend since early 2009.

It is not that difficult to spot the trend that something is currently in, although it is necessary to develop at least a minimal skill level in interpreting charts to do so, and especially to match the length of the chart to your desired time frame.

With investing, this means mostly looking at monthly charts for overall trends, which will yield positions lasting at least a couple of years if that’s the strategy one wishes to use. Shorter term strategies involving weekly charts can work for those who are looking to time their investments more, although shorter time frames such as daily or intraday charts are more suitable for traders who are looking to hold positions for less than a year.

This does take some skill and perhaps more than is apparent at first glance, but these are skills that are well within reach if one has the desire to acquire and develop them. One does not have to be extremely bright to become proficient enough at this, or have a lot of experience, although being bright and experienced certainly does help.

None of this necessarily involves spending much time analyzing one’s investments, especially looking to manage longer term positions, and a few minutes a week is all that is needed really. One’s level of interest and especially one’s confidence are the important factors here, more than anything, as well as an open mind to be able to set aside all the talk of how difficult this all is supposed to be that is so bandied around.

The most important component of all of this is the ability to execute your plan effectively, and this is where many investors go wrong. The psychological side of things is the biggest roadblock in trading, and although investing involves fewer decisions, one must still be able to execute the plan and not let one’s fears or even greed stand in the way of proper decision making.

All in all, it takes far less talent to be able to do well at investing than most people suppose, and far less time than they may think as well. Provided one feels that they have the means to come up with and execute a good plan, and one is dedicated to learning, and there is some learning involved here to be sure, than one can put oneself in a good position to succeed at this game.

Andrew Liu


Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.

Contact Andrew: [email protected]

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