By Eric C. Jansen, ChFC®
Do you feel knowledgeable about where you invest your money and how you do it? You might be a good investor right now but what could your portfolio look like if you were even better? If you want to take your financial performance and ability to grow wealth to the next level, take a look at these five tips that will help you become a better investor than you are today.
1. Link Your Investments to Your Goals
It’s tempting to think there’s one best way to invest your money. While certain strategies are better than others, there’s no universal solution. Using the investment strategy that’s best for your specific situation means you need to evaluate your investments in the context of your goals. Start by asking yourself why you’re investing and what you hope to achieve. The answer will inform how you should invest and help you if you’re interested in being a better investor. (For more, see: How to Avoid Common Investing Problems.)
Your goals dictate your asset allocation, your time horizon and your tolerance for risk. Therefore, examining what you want to accomplish helps you understand critical factors that determine where and how to invest.
2. Reassess Your Plan and Goals Periodically
That being said, life changes. Goals change. And when things change, you may need to update your investment strategy to reflect that. That doesn’t mean tinker with your investments on a monthly basis. But it does mean you should take the time to review your plan each year and ask yourself if your investments still align with your goals. Each year, evaluate your strategy and ask questions like:
- When do I want to use this money I’m investing?
- Has anything changed how I think about risk?
- Am I still diversified?
- Do I understand the holdings where I invest?
- What do I need to better understand?
These are important things to consider, but reviewing your investments doesn’t mean you must make changes. In fact, sometimes the best action to take is no action at all.
3. Understand the Difference Between Risk Tolerance and Risk Capacity
You probably understand risk tolerance - the amount of volatility you can handle in your investments. With a high risk tolerance, you agree to accept seeing big swings in your portfolio. You’re comfortable living with unrealized losses and confident in your ability to ride out market downturns without panicking. If you have a low risk tolerance, you know you don’t want to deal with wild swings and lots of volatility, so you can invest accordingly. (For more, see: What Is Your Risk Tolerance?)
No matter what your risk tolerance is, however, it’s not the same as your risk capacity. While risk tolerance is subjective, risk capacity is objective. It’s how much risk you can actually take with your investments and that’s determined by how much you need to meet your goals.
Being a better investor means you understand that while you may feel completely okay with taking big risks, you know you can only take on so much risk as dictated by your goals.
4. Diversify Your Portfolios and Accounts
You already know the importance of asset allocation and diversification within your investment holdings that make up your portfolio. But do you diversify the types of accounts your portfolios live in?
Investing in 401(k)s and IRAs is a good place to start. These accounts do limit when and how you can use your nest egg, however. Because you can only dip into these accounts (without penalty) at retirement, you might want to consider where else you can invest money to grow wealth for other important aspects and stages of your life before or outside of retirement.
Again, you need to consider what your goals are. Then make sure your accounts are properly diversified to empower you to not just have the money for those goals, but the ability to access the funds you need when you need them. (For more, see: The Importance of Diversification.)
5. Remove Opportunity for Human Error
Most average investors underperform the S&P 500. Why? Because the S&P 500 just tracks the market. It doesn’t make decisions about what to do. It just does. Average investors are human and prone to making human errors driven by emotion. If you want to be a better investor, you need remove the opportunities you might have to make emotional, irrational decisions. Here are a few ways you can accomplish this:
- Set an investment strategy and plan based on your goals.
- Automate what you can, from your contributions to rebalancing.
- Work with an objective third-party who can help you stick to your investment strategy when you’re tempted, in the moment, to deviate from it.
Being a Better Investor Means Being Self Aware
Good investors understand how to set a plan and stick to it over time to grow wealth. They can DIY to reach some success in the market. But the best investors have the self awareness to recognize when they could benefit from having a fiduciary advisor on their team to provide guidance, advice and navigate around the investor’s own blind spots. It’s usually not the things we know we don’t know that trip us up. It’s the things we don’t know we don’t know.
Using these tips can help you become a better investor but that last point on how to eliminate opportunities for mistakes is one of the most important to consider. (For more from this author, see: What to Do When You Receive an Unexpected Windfall.)
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This article was originally published on Investopedia.