There are three keys to greater wealth from investing: philosophy, strategy and discipline. The best returns go to those who have a sound investment philosophy, create a workable plan based in this belief, and diligently follow their plan. These steps sound easy, but they're very difficult to execute. Most people need help getting it done.
Ask experienced advisers how many portfolios they've reviewed that lack philosophy, strategy, and discipline and you'll make them laugh. That's because almost all portfolios lack these elements. Investors say they've got them, or think they have them, but their portfolios don't show it. They hold a smorgasbord of randomly collected investments that have no relationship to each other except that they all tend to be popular ideas from days gone by.
An experienced eye will spot this trail of trends reaching back many years and can estimate each one's purchase date. When I review a portfolio, I'll often I say something like, "I bet you bought this emerging market fund around the summer of 2007 and that commodity fund in early 2008." I'm right most of the time. How do I know? That's when other undisciplined investors were buying the same funds!
Undisciplined portfolio performance is easy to calculate even without detailed statements. That's because it is always well below the markets. Yes, I did say always. I have never come across an undisciplined investor who has come close to a market return over the long-term. Never!
When actual results are compiled using past brokerage statements, undisciplined investors are disappointed to learn that their portfolios have performed so poorly. It's more of shock when they see these results compared to a simple index fund portfolio such as the Core-4 because the "performance gap" is huge. This gap between investor returns and index returns has been documented many times by research firms such as DALBAR and Morningstar.
People who see a comparison of their performance to index funds readily admit that they should have been more diligent. Some will blame themselves. Some will blame their brokers who were supposed to "watch their portfolio" for them. It's sad to hear these stories because investment returns have been difficult for several years and this extra gap often leaves their portfolios in sad shape.
How does an undisciplined investor become disciplined and earn a fair return? Here is my three-step plan. It's not an easy plan, but it works.
I'll use myself as an example:
1. Commit to a long-term investment philosophy:
Rick's Example: I believe the markets are relatively efficient and that my best chance for financial success is a market return. I am a "passive investor" who believes that market representation alone provide the highest probability for success. I acknowledge some people have done better, but that's a rare or lucky event, and betting on it isn't worth the risk or cost.
2. Create a strategy based on your investment philosophy:
Rick's Example: I have created a long-term asset allocation based on my financial needs. I have selected low-cost index funds and exchange-traded funds (ETFs) to represent the asset classes in my portfolio. Occasionally, I will rebalance my portfolio back to its long-term asset allocation. This will control risk. There is little reason to change this portfolio unless something changes in my life. I will not succumb to those who promote "beat the market" strategies because by default those methods are higher cost and lead to lower returns.
3. Get invested, stay invested, and be disciplined:
Rick's Example: I am vigilant in my belief and disciplined in my way. My portfolio is fully invested in low-cost funds and will stay that way. I will not waver in the face of market volatility or procrastinate when maintenance is needed. I will not be influenced by "market gurus" who make money by selling useless predictions. This is my life, my money, and my one shot to get my retirement portfolio right!
Philosophy, strategy and discipline are the keys to successful investing. Rewards go to those who have a sound philosophy, formulate a sensible strategy, and implement their plan completely.
This three-step plan sounds easy, but it is extraordinarily difficult to implement and maintain. Many people will need a helping hand. For those who desire a firm to do the investing for you, a low-cost investment adviser such as my firm, Portfolio Solutions, charges a nominal annual fee to advise clients and manage accounts.
It doesn't matter which path you choose to make the three steps work, the job needs to get done. Do it yourself, get help, or hire a low-fee adviser. You'll be wealthier for it.