Want to Become a Successful Investor (Even in This Environment)? Here's What It Takes

By Jeff Miller :

Most of those in the baby boomer generation are scared silly. They are worried about retirement -- even poverty. In the best case many now expect to work much longer before retirement.

Investment mistakes have been part of their problem. If they make more mistakes, there will be no solution.

In this article I will provide an outline of the thought process required to be a successful individual investor. Then I will suggest some ideas about how this applies right now.

The Background

Suppose you are an average person, looking toward retirement, with more than a few years in your investment time horizon. You are intelligent and capable. You make decisions with confidence, and without emotion.

If you have these attributes, this article is for you. If you don't have them, this article is really for you.

Characteristics of the successful investor

This is a very brief outline of what you need to succeed. Each step is essential. This is not graded on the curve!

• Understand the need to plan . If you do not have one, you are completely adrift and will almost certainly fail.
• Know how to plan and how to evaluate the outcome. If your plan does not include adequate return or protection against inflation, you cannot expect to meet your retirement goals.
• Choose investment approaches that will meet your goals -- both risk and reward. Don't kid yourself! Do not pretend about risk tolerance. Know the expected volatility of your investments.
• Understand your time frame . The best way to meet long-term goals is through long-term investments. This does not mean "buy and hold." Active management requires finding good themes, weeding out losers, and rebalancing your portfolio.
• Adopt a system . Discover a method for selecting stocks or ETFs that you know and understand. Find a way to test or to verify the results. If you do not have confidence in the system, you will abandon it at the worst possible time.
• Find warning indicators. You need to know if something really unusual is happening. Some said that 2008 was like a 100-year flood. That might be an overstatement, but you want to have an objective indicator of that kind of problem.
• Stick to your system . If everything is within normal ranges, then there is no reason for alarm.
• Beware of the news. The news is always about problems and potential disasters. Some of it comes from those profiting from your fear. Widely publicized worries are reflected in market prices. It is the unexpected --the true black swan -- that requires attention.
• Do not use political opinions in your investing. We are in a state of perpetual campaigning. There is always something wrong and we can count on the "outs -- either party" to make it all see terrible.

And finally, if you have done all of these things right:

Give your plan a chance to work.

At times like now, many investors are wondering why they are not traders. Someone -- their neighbor at a cocktail party perhaps -- sold at the very top. The neighbor might do better, assuming that she buys back in. You have many neighbors and the successful ones will always have a story to tell:)

My experience is that trying to mix the trader and investor approaches does not work. If you want to do this, you should allocate part of your account to each method. The problem is that the rules and the psychology are completely different. The trader does not -- must not --- care about fundamental values. His time frame is too short, and his daily stakes are too high.

The other key is that the investor buys stocks that are hated by the market, especially by traders.

Wise Advice

Contrast the trader mentality with the advice of our generation's best investor, Warren Buffett, who was asked how an investor could be sure that an undervalued stock would eventually rise:

and similarly:

Many successful trend-following traders, including our Felix model, would disagree with that last statement, but it does highlight the difference between two perspectives - both of which are successful.

The investor should emphasize the value of the business, not worrying too much about the value on his statements. One a year or so is often enough. It is a different mentality.

The Current Prospects

In my weekly column on "the week ahead" I take a short-term focus, but also highlight factors of more general concern. The trader approach has now been bearish for a few weeks. This reflects market sentiment and trends. Despite this, for long-term investors the current environment represents an exceptionally attractive opportunity. The highlight factor is the widespread misperception about the misnomered "end" of QE II , which will soon be known as the Y2K non-event of this decade.

In the last decade we saw an exception to progress. The decade started at a time when demand and sales had been pulled forward. Everyone worried about Y2K and bought computers instead of fixing software. It was an unprecedented and exceptional boom, augmented by Internet fever. The decade ended with a financial crisis -- also of unprecedented proportions. Taking this time period is starting with an atypical peak and going to an atypical trough.

Those who choose to take the last market decade and use it to predict the next, do not understand anything about history, progress, statistics, or causal inference.

For the fearful investor, your choice is clear. You can be a deer in the headlights, mesmerized by fear, and watching inflation eat away at your remaining assets. That is the slow road to realizing your fears.

Or you can take control.....

There are many, many stocks trading at dirt cheap PE ratios. If you read widely, you already know this. My very wise SA editor (who never takes any credit) encourages me to include stock ideas, so here are a few prominent ones, hated by traders and trashed in news stories. That is good news for the long-term contrarian investor.

I have recently mentioned JP Morgan Chase ( JPM ) and Oracle ( ORCL ). Even some noted market skeptics have recently opined in favor of Goldman Sachs ( GS ) and Microsoft ( MSFT ). My list of qualifying stocks is much longer -- companies that have had great earnings and confirmed strong outlooks.

[I'll share some links on these points and a few ideas in upcoming articles in this series. Most of the topics are familiar to readers but the team will help me with some citations. I hope this is a good start.]

See also Citigroup Still a Sell on seekingalpha.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.