Keeping Your Investment Strategy Simple
[dropcap background=”” color=”” circle=”0″]E[/dropcap]veryone knows that personal investment is integral to their financial future. However, surveys have shown that only one in four people actually take the time and put forward the effort to commit their plan to paper. One of the main reasons for this may be that too many people feel overwhelmed by the process. If this sounds like you, the good news is that a simple strategy is actually the best approach.
The Problem with Complexity
As we’ve already touched on, the problem with a complex approach is that most people never endeavor to begin it. The very thought of creating an investment strategy with a million moving parts seems far too difficult for the layman.
Worse still, those who actually create a complex plan are usually sabotaging themselves. These plans are far too difficult to follow and the result is that people fail and become convinced that personal investment is something beyond their grasp.
The Problem with Too Much Data
Many people understand this concept, but still shoot themselves in the foot because they refuse to get started until they have “all the information.” The truth, though, is that there is simply too much information when it comes to investing to ever have all of it or even a majority of it. Multinational investment firms can’t even get their arms around the bulk of the information, so you shouldn’t expect yourself to either.
Furthermore, time and time again, studies (e.g. Tsai et al., 2008, Huber et al., 2008) have shown that too much information may actually be counterproductive. An overabundance of it gives people a false sense of confidence, which then leads them prone to make mistakes.
In fact, these studies have actually shown that despite having more information, most people don’t actually make better decisions.
Investing in the Right Number of Stocks
When you begin investing, your intuition will generally tell you to go one of two ways:
- Invest in just one stock
- Invest in as many stocks as possible
However, both of these plans carry key risks with them that should be avoided. If you only invest in one stock, the risk is obvious: the company could crash and you’ll lose all your money.
This is why conventional wisdom is to diversify your portfolio with as many stocks as possible. Unfortunately, this advice is impractical. You can only invest in so many stocks, after all. The key may be knowing what the magic number is.
When it comes to personal investing, this number tends to be around 10. One reason is there is just so many stocks you are able to keep track of and another is that 10 stocks are enough to reduce a lot of risk.
Given people’s financial woes, then, it should come as no surprise that most investors hold far fewer than 10 stocks. Barber and Odean have throughout the years investigated individual trading and investment behavior and concluded that most investors tend to hold undiversified portfolios.
Know Your Limits
That being said, you need to understand what your limits are as far as investing goes. Managing 10 stocks is definitely no easy task. While strategies like dollar-cost averaging can help, you also need to be realistic. Everyone loves a good winning story, but the losers tend to outnumber the winners.
Even in places like Asia, where the market continues to climb, returns over the past decade were only about 10%. This is why it’s important to look at your investment strategy with a telescope: you’re putting money aside that will grow slowly but surely over the decades to come.
Owning Mutual Funds
For personal investment purposes, then, your best bet is probably to go with mutual funds. They will mitigate the risks of buying stocks in individual companies, while providing you with long term growth. In many ways, mutual funds represent the best of all worlds.
Keeping it simple is key to a successful investment strategy. While this means resisting the urge to add a million elements to your plan or attempting to harvest all the data out there, it also means thinking about the investments themselves. For most people, mutual funds are an ideal solution that assure simplicity and returns.