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.