We have all heard stories of people who have achieved great investment success. But what do you need to generate successful returns and keep your sanity along the way?
People view investment success as ultimately about what return you can generate over a period of time. While that is certainly a valid benchmark, how you get there and the peace of mind that you have with your investments is equally important in keeping you sanity over a long period of time in my view. It's not only about how much money you make, but doing so in a way that minimizes your stress and worry that makes someone a contented investor in my. In any case, I think there are a few key things you need to cover to get on the path to investment happiness.
Know your risk tolerance
Having a view of what you can stomach in terms of movements in your capital value can be very important. If you can't tolerate large volatility the stock market may not be the right place for you, because declines in market value can mean that you sell out at precisely the wrong time (when markets are at their lowest points). In that context an investment in fixed income securities like bonds, while providing a lower return, may be better for you over the long run. Investment in individual stocks also comes with it a potential loss of capital, so if that's something that you are fearful of then holding an index fund (which is simply a basket of stocks that track an index like the Dow Jones for instance) may be better. Having a lower risk tolerance may also mean that you are better off by avoiding things like investment loans and buying stocks on margin. Buying on margin can boost your return on equity, but also has substantial risk as well.
Understand what you are invested in
If you understand how the business that you are invested in works, and how it makes money then its highly likely that you can pinpoint the growth drivers that will continue to help that business make money, or alternatively things that will cause the business to lose money. Understanding the business that you have invested in will make you a little less panicky when there are large swings in the share price, as you should be able to understand the drivers of the business better and work out if there are material changes in the business that are taking place.
Research & Monitoring
Whatever it is that you are invested in, understanding what it is that you are invested in, how much you are paying for that investment and monitoring that investment is very important. In my view this holds true for whether its an individual stock that you are looking at or even an index fund. Individual stocks can be affected by a number of factors that can influence their individual performance including new competitors, or new trends in the market. Index funds are often weighted by market capitalization, so the performance of an index fund is likely to be heavily weighted toward the higher capitalized companies in a given index. If you don't have a positive view on these companies, it could be worth your while considering if you want to be in that particular index fund.
Unless you happen to be an extremely skilled trader that can profit from short term movements, its likely that any strategy you implement will take some time to see results. Having the patience for those results to emerge without continually chopping and changing is crucial to success. I view investing in stocks as similar to investing in a business. You typically don't sell a business in 1 or 2 months if you don't see a dramatic increase in performance. It takes time to see sustained performance and improvements in valuation. Having patience with your investments will allow the power of compounding to come through over a long period of time.
Courage to Seize opportunities
I have always loved Warren Buffet's saying "buying a $1 for $0.50". Its much harder to put this into practice though. This involves moving into a stock when everyone else is abandoning it, or when markets are tumbling. Some of my best purchases historically occurred during the depths of 2009. I picked up American Express (AXP) at $15.00 when it was on a yield of almost 5% and Caterpillar (CAT) at $31. I exited both of those stocks later in 2010 for multiples of what I paid for them. This even holds true for investments in index funds. Buying additional units at low points and not selling can be financially rewarding over the long term. While you don't need to seize bargain investments to be contented, doing so will certainly boost your investment returns!
Getting into a stock when everyone else is running away from it can be extremely lucrative if you have done the research.
Conviction & self belief
In my mind this is probably the most important one. No investment philosophy or strategy in the world is not going to be successful for you if you don't believe that it is correct. The slightest fall in stock price can send you scurrying for the exit door even though there may be no legitimate reason for that to happen. It could just be Mr. Market having a bad day. More than anything, self belief in a strategy is what will help give you peace of mind over a long period of time. For me, that conviction comes from underlying performance of a business. Because my focus is on the performance of business rather than how it trades, I'm not bothered so much about price of the stock. If the performance looks like it may be affected, then I'll certainly reconsider my position, but until then, I'm happy to stay put.
Are there other ingredients that you think you need to be a contended investor?