The question of how to become a smarter investor is one that most people confront at one time or another. Answering this question can be complex but it usually starts with finding or discovering intelligent investment ideas and constructing a portfolio around it to fully exploit the benefits of these ideas. Easy to say, but not so easy to do in practice, yet it can be achieved by carefully following these six guidelines.
Find intelligent investment ideas for your portfolio
It all starts with the investment idea or strategy. Becoming a smarter investor means implementing investment ideas that are grounded in the best economic principles for success. If you don’t get this right it makes it much harder to achieve great results. Think about what signals or selection criteria you will need to trigger your investment decisions. Do these make logical sense or are they based upon emotion with no basis in a scientific approach?
Investment ideas determine the trades that are made. Many investors chase the market in search of the next hot trend instead of investing for long term value. This is a high risk way to go about investing, and definitely not being a smart investor.
When trying to find the right investment strategy, you must also look at the historical backtest (sans survivor-bias) or the track records of that strategy, or alternatively, similar strategies, if they are available through academic research. Have they been successful? Do you have evidence that they’ve performed well or is it just something that you heard?
Construct your portfolio with intelligence
An investment idea or strategy isn’t just about top line economics or data science or generating successful trades. It’s also about what this means on the overall portfolio level. How are you going to structure your portfolio with your investment idea?
Managing exposure of investment ideas are fundamentals in portfolio construction and management strategies and you must choose one of several types: from active management to passive buy and hold strategies, or even Direct Indexing. All these will determine the positions you currently hold versus the ones that you should hold and with time, you need to make sure that the positions you hold are still in line with your original portfolio ideas or your portfolio selection criteria as you want to avoid “investment strategy drift”. Rebalancing each position exposure will also be key to make sure of this.
Know your costs
If you want to become a smart investor, you must look at what it is costing you. Are you aware of all the fees you are paying and what fees you really need to pay? You need to be smart about this.
There are several drivers of expense in any investment portfolio. If you are not a DIY smart investor, the first and most obvious one is management fees that you will pay an advisor to execute your investment idea or strategy. They are often quoted as a percentage of the assets managed or AUM as it is known in the industry. They might include not only fees for managing the assets but fees for the trades made, aka trading commissions. If they are not included, you need to factor in the trading commissions. When choosing an investment platform to manage your portfolio, know that some platforms offer free trading while others require you to pay a ticket charge for each trade.
An indirect cost of investing is the time consumed. If you are managing your own money, consider the time and mental energy that it takes to do this right. Read How Much Time It Actually Takes to Manage Your Own Money for an estimate of what it will require to run an investment portfolio on your own time.
Unfortunately most investors never sit down and assess what returns they are getting after all the fees are paid. If you are paying a financial advisor to manage your money, for example, there are several things they could do be doing to lose your money. Very often in any investment program there are fees that the investor isn’t aware of; do the homework and get to the bottom of it.
In summary, executing efficiently your investment idea is as important as finding the right or smart investment idea for your portfolio.
Stay on top of things
If you are active in the market, you have got to stay on top of your investments on a regular basis. Before investing your portfolio with a smart investment idea, you should have conducted a risk assessment to determine where you stand on the risk spectrum. You may be a conservative, moderate, or aggressive investor, or somewhere in between. Know what your risks expectations are. This is very important before you invest in anything, even if it’s the best investment idea in the world.
You might also want to consider how your investment goals may change in the future. Perhaps when you started out, you were an aggressive investor. But maybe you changed jobs, started a company, bought a house, or had kids. Now all of a sudden you’re not as open to taking risk. At one point in life maybe you were looking to grow your portfolio while now maybe you’re seeking higher income in the form of dividends and interest. Just as your risk tolerance may evolve, so may your overall objectives. Be smart, recalibrate your selection of investment ideas at least once a year.
Approach tax planning carefully
Many financial advisors and roboadvisor platforms preach the benefits of a strategy called “tax loss harvesting” in which the losses taken on any one particular security are netted against each other. This may make sense to do on a periodic or ongoing basis. While this can perhaps be a viable strategy, investors should be wary of anyone who claims to produce “tax alpha” that represents a significant source of superior performance when done on an ongoing (daily) basis. There are several reasons according to a 2014 article by Michael Edesess *.
- Frequent trading to minimize your tax burden will potentially drive up transaction costs
- Evidence of superior performance with a tax strategy is in many cases debatable
- Beware of the the IRS “wash sale” rule when buying and selling a similar security to offset a capital gain
While tax awareness is an important part of becoming a smarter investor, consider that an improper tax harvesting strategy may just do you more harm than good.
Find the right platform
If you want to become a smart investor, it’s also about finding the right platforms for you. But with so many available, how do you know which ones is the best? We recommend keeping things simple. You don’t have to work with a ton of different programs; choose one or maybe a couple that you know well and have researched thoroughly.
It’s important to keep in mind that companies are always changing. You may experience changes in the fees, technology, what they offer, customer service, or just plain the way the company works with investors. Staying on top of this is important if you want to become a smart and better investor, but as we said, the more platforms you are doing business with, the harder it is.
Investors have many choices to pick from, whether it is a roboadvisor, full service trading platform, or a human financial advisor. It is recommended to perform initial and ongoing due diligence on at least an annual basis for anyone you enlist to help you with this.
Summary of how to become a smarter investor
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* Sources: Edesess, Michael. (12 August, 2014). Advisor Perspectives. The Tax Harvesting Mirage. Retrieved from here