Investing Tip #3: Have a Process

We all know someone who never seems to know what they want to do with their life.  They jump from job to job, or relationship to relationship, or hobby to hobby.  We shake our heads and say to ourselves, “Gee, they need to put down some roots!”

The thing is, many of us can be like this when it comes to investing.  We read an article about how XYZ investment may double over the next year.  So we buy it.  Three months later, we hear some pundit on TV explain how ABC investment is a sure thing.  Since XYZ hasn’t shown any signs of doubling, we sell it and buy ABC.  This we call investing. 

The unfortunate reality is that this behavior usually leads to mediocre results.  According to Dalbar Inc., an investment research think tank, the S&P 500 stock index returned 8.2 percent over the 20 years ending in December 2012.  During the same time, the average investor earned just 4.2 percent.     

In case you think I’m just pointing fingers at ordinary folks, trust me I’m not.  We investment “experts” are subject to the same craziness.

It probably won’t surprise you that esteemed investors such as Warren Buffett, George Soros, and Peter Lynch don’t manage their portfolios flying by the seat of their pants. 

All of these men have radically different ways to invest, but they are alike in one way.  They all have a time-tested process, and they stick with it no matter what.

Here are five characteristics a good investment process should have:

1. It should fit your personality type.  If you are conservative by nature, it’s unrealistic to think you’ll be comfortable with an aggressive process.
2. It should fit your goals.  If you are planning to retire in a year or two, getting ultra-aggressive could be dangerous.
3. It should be clearly defined.  The strategy:  “I’m going to invest in stocks that have been going up lately” is too vague.  On the other hand, “I’m going to invest in the ten stocks that have returned the most in the past 12 months” is clearly defined.
4. It should be back tested over decades.  How has the process done over the past 20 or 30 years?  Some back test their processes for just three, five or ten years.  That barely covers the last bear market, let alone several.
5. It should be logical.  At the end of the day, the process should just make sense.  Believe it or not, there are people who invest in stocks if a NFC football team wins the Super Bowl and sell stocks if an AFC team wins.  Although this system is 80% accurate, what does football have to do with the stock market?

Having an investing process is key to reaching your goals.