5 habits of effective investors

Acknowledgment: We borrowed loosely from the title and concepts of the self-improvement book published in 1989 by US management guru Stephen Covey called “7 Habits of Highly Effective People”.

Habit #1: begin with the end in mind.

Let’s start with one of those “habits” – habit #2 in Covey’s book – “begin with the end in mind”. Of course, Covey was thinking about living an effective life rather than charting a successful investment journey. But the principle is still applicable here.

First, define what “success” is. Is your investment intended for a specific short-term goal (buying a car, perhaps) or a long-term one – retirement? For most investors, it is the latter. Your strategy and time frame will differ, depending on your goals.

There are short-term traders and there are long-term investors. A major cause of losses is confusion between time frames and strategies. Traders take their fortunes and their skills in their own hands. Some succeed, some don’t. But history tells us long term investors rarely lose money if they buy into blue-chip stocks in established markets.

The losers are typically the supposedly “long-term investors” who take fright at the first market fall they experience and sell at a loss. After selling, they will typically struggle with the timing of when to get back in again. Often, they don’t get back in at all.

So, if the end of your journey is in 20 years, don’t trade in and out as if the “end” is 2 months.

Habit #2: do it early and do it often

Habit #2: Do it early and do it often

The earlier you start, the more you will have when you finish. Stephen Covey spoke of “being proactive” as one of the habits of highly effective people. He also spoke about “putting first things first”. It was about taking charge of your growth, delaying gratification and focusing on doing things that will make a big difference to your life.

In the context of growing your wealth, that means saving and investing early. And doing so consistently too. There are regular savings plans which would allow the young to start investing from as little as $100 a month. So, there is no excuse for delaying investing for your future. The generally bullish long-term history of stocks in established markets and the power of compounding will work in your favour the earlier you start and the longer your time frame.

Habit #3: spread your risks

Don’t put all your eggs in one basket. No matter how much you like a company, you should not put all your money in one stock. Indeed, many unit trusts (sometimes called “mutual funds” in some countries) hold around 40-50 stocks in their portfolios – which means an average of around 2% per stock.

An easy way to spread your risks is to buy an exchange traded fund or a unit trust that invests in a specific geographical market or sector.

Beyond avoiding what’s called “single stock concentration risk”, you can further diversify by adding bonds to your portfolio. Again, you should avoid concentrating your funds in a single bond. A problem is that corporate bonds sold to so-called “Accredited Investors” (that is, experienced investors who meet minimum income and asset criteria) are traded with a minimum sum of $250,000.

What you can do is diversify your portfolios into bonds via either an exchange traded fund or a unit trust.

Habit #4: allow yourself a little risk, and a little “market timing”

The virtues of diversified portfolios are time-tested. But that doesn’t mean you can’t allow yourself a little calculated risk – for a stock that you think is undervalued and should do much better when sentiment turns.

Commentators sometimes misinterpret billionaire investment guru Warren Buffett’s wisdom, assuming he never times his investments. Yes, it is true he doesn’t believe it is possible to consistently win by timing the broad market. But he does time his purchases of specific stocks depending on their quality and the valuations at specific times.

And Warren Buffett does appear to occasionally indulge in broad “market timing”, buying more when there is widespread fear and loathing. One of his most famous quotes is: “If they (investors) insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful.”

None of this contradicts habit #2. It should never be an “all or nothing” endeavour. Allow yourself a larger, but still manageable, investment of say 5% of your portfolio in a stock that you have properly analysed as sound and undervalued. And allow yourself to buy more quality stocks (stress, quality) when there is widespread market fear.

Habit #5: discipline, discipline, discipline

Habit #5: Discipline, discipline, discipline

There are equally powerful temptations to sell out of greed and fear.

Fear: When markets are falling, the temptation is to “cut loss”. You might legitimately consider that if you’re close to retirement. But then, a proper financial plan should gradually reduce holdings of stocks in favour of high quality bonds as the investor ages anyway. That should already be part of a disciplined financial plan. So, there should be no need for panic selling – particularly if you’re in, say, your seventh year of a 30-year plan. History favours the long-term investor.

Greed: When markets are surging, it is equally tempting to “take profit” (and usually spend it frivolously!), only to see the investment much, much higher in 10-20 years.

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