Successful investing is about making intelligent, informed decisions that will yield the best possible outcomes over time.

For the do-it-yourself investor managing a diverse portfolio of stocks, bonds, cash, and alternatives, such as real estate and commodities, success hinges on more than just understanding the markets—it's about cultivating a disciplined approach to wealth management.

In this note, we delve into the ten key habits that define successful investors. These habits are not just practices but principles that help manage risk, enhance returns, and align investment actions with long-term financial and personal goals.

Whether you're a seasoned investor or just starting to manage your retirement savings, these habits can provide a foundation for decision-making that is both wise and effective.

By adhering to these principles, you can not only protect your assets but also grow them, ensuring a financial strategy that resonates with your vision of a prosperous future.

1. Understanding Risk and Return

Successful investing begins with a fundamental understanding of risk and return, a concept that dictates nearly every financial decision an investor makes.

Risk and return are inherently linked; generally, higher potential returns come with higher risk. Thus, an investor's primary challenge is to strike the optimal balance of assets that aligns with their individual risk tolerance and retirement timeline.

For investors, it’s crucial to understand the basics of capital market history. Using the history of the US capital markets as a guide over the 1928 to 2023 time period we observe the following relationships:

• Asset Classes with higher volatility tend to perform the best, on average

• Asset Classes with higher volatility tend to exhibit a higher frequency of loss

• Cash is the only safe asset with a zero percent frequency of loss

• Inflation varies year by year with an 8% frequency of a disinflationary occurrence

Design your portfolio to include a mix of asset types. Typically, stocks offer higher returns with higher risk, whereas bonds can provide regular income and are generally less volatile. Cash investments, while offering lower returns, provide liquidity and safety.

By understanding the basics of capital market behavior you will be able to effectively manage the inherent risks of investing.

2. Emphasizing Asset Allocation

For DIY investors, particularly those managing their retirement funds, it’s crucial to assess how much risk is acceptable.

Remember risk and return are intertwined.

• Are you comfortable with large swings in investment value if it means a potential for higher returns?

• Or do you prefer a more conservative approach, accepting lower returns in exchange for greater stability?

Conduct a thorough risk assessment. Consider factors such as your age, income needs, life expectancy, and other financial obligations.

Tools like risk tolerance questionnaires can provide valuable insights into how much risk you can comfortably take on.

The diagram below can also help you figure out what type of asset allocation mix is best for you.

Once you have a grasp on how much risk you decide is appropriate pick your asset allocation mix target weights. The key here is to stay diversified by spreading your investments into a suitable mix of equities, bonds, alternatives, and cash.

Diversification is one of the most effective strategies for managing risk in an investment portfolio. By spreading your investments across various asset classes, geographic regions, and sectors, you can significantly reduce the impact of any single investment's poor performance on your overall portfolio.

Diversification helps mitigate the risk of loss and can lead to more consistent performance over time. It’s about not putting all your eggs in one basket, whether that basket is a single asset class, sector, or even a country.

How to Implement Your Asset Allocation:

Asset Targets: Divide your investments among different asset classes. A mix of stocks, bonds, real estate, and commodities can balance your risk and return.

Asset Maximum and Minimum Weights: Decide how far you’re willing to deviate from your target weights. I recommend setting your asset class ranges to ±5% from the target.

Here are three representative asset allocation strategy mixes you might consider.

Sector and Geographic Diversity: Within your stock holdings, invest in different industries and regions. This reduces the risk that a downturn in one sector or area will significantly impact your portfolio.

If you invest in broad-based ETFs you are already diversified in proportion to the market capitalization of the capital markets.

Implementing these strategies not only safeguards your investments but also positions you to capture growth across a broader range of opportunities.

Asset allocation isn’t about eliminating risk but about managing it in such a way that enhances your ability to achieve consistent, long-term returns.

3. Controlling Costs

Controlling costs is a crucial habit for successful investors, especially those managing their own portfolios. Even small fees can compound over time, significantly reducing your overall investment returns.

Being vigilant about costs involves more than just avoiding high-fee funds; it also includes understanding all the ways expenses can eat into your returns.

There are generally two types of direct costs you can control:

• Fund and Trading Fees

• Advisor Fees

Strategies for Minimizing Investment Costs:

Choose Low-Fee Investment Options: Look for ETFs (exchange-traded funds), index funds, and mutual funds with low expense ratios. These funds often provide the benefit of diversification with minimal costs.

Avoid Excessive Trading: Each trade can carry costs, including brokerage platform fees and potential tax implications.

Advisor Fees: If you are a DIY investor you’re saving yourself a ton of money, but you may be missing out on the expertise and training of a professional.

Alternatives to “assets-under-management” fees include paying a flat annual fee or paying a “by the project” fee.

In any case, advisor fees should be commensurate with the value you’re receiving.

By being mindful of where every dollar goes and choosing cost-effective investment strategies, you can preserve more of your returns, enhancing your portfolio’s growth potential over time.

4. Minimizing Taxes (of the legal kind)

Tax efficiency is a critical component of successful investing, especially for those managing their own portfolios.

By optimizing your investments for tax implications, you can significantly enhance your net returns without taking on additional risk.

Key Aspects of Tax Efficiency:

Choosing the Right Accounts: Utilize tax-advantaged accounts like Roth IRAs, traditional IRAs, and 401(k)s to defer taxes or pay them at potentially lower rates in the future.

Asset Location: Place highly taxable investments, like certain bonds and REITs (Real Estate Investment Trusts), in tax-advantaged accounts, while keeping more tax-efficient investments, such as stocks held for the long term, in taxable accounts.

Tax-Loss Harvesting in Taxable Accounts: This strategy involves selling investments that have incurred losses to offset taxes on gains and income. Executed correctly, it can significantly reduce your annual tax bill.

Example: An investor might choose to hold dividend-paying stocks in their Roth IRA where dividends grow tax-free. In contrast, they could place municipal bonds in a taxable account since the interest from these bonds is often exempt from federal income taxes.

Implementing these strategies requires a good understanding of both your current tax situation and potential future changes in tax legislation.

5. Putting Distance Between Your Emotions and Actions

One of the most challenging aspects of managing your own investments is maintaining objectivity and removing emotions from your decision-making process.

Emotional investing can lead to common pitfalls like panic selling during market downturns or overly aggressive buying during bubbles, both of which can harm long-term investment performance.

Strategies to Stay Clear-Headed:

Set Clear Investment Guidelines: Define your investment strategy and stick to it. Having clear guidelines helps you make decisions based on logic and research rather than emotion.

Long-Term Focus: Always remind yourself of your long-term investment goals. Short-term market fluctuations are normal and should not derail your long-term investment plan.

Know When To Look and When To Look Away: When the market is experiencing stress it is best to put some distance between your emotions and your actions. Take a break. Focus on other parts of your life until your emotional makeup is stable. Time is your friend when it comes to investing!

Example: Imagine an investor reacting to a sudden 10% drop in the stock market by selling their equity holdings out of fear. This panic selling can lock in losses and prevent them from benefiting from potential market recoveries.

By adhering to pre-set investment guidelines and focusing on long-term objectives, investors can avoid such knee-jerk reactions.

6. Review and Rebalance Your Portfolio

Regularly reviewing and rebalancing your portfolio is essential to maintain the desired asset allocation and to respond appropriately to changes in the market or in your personal financial situation.

This discipline ensures that your investments continue to align with your risk tolerance and investment goals.

Why Regular Review Is Important:

Alignment with Goals: Market movements can cause your initial asset allocation to drift. Regular reviews help ensure your portfolio still reflects your desired risk level and investment objectives.

Opportunity to Adjust: Economic conditions, market forecasts, and changes in your personal life may necessitate adjustments in your investment strategy.

Keeping It Real: Investing is about dealing with reality. The price on the screen is the right price (even if you don’t agree!). Markets don’t always reflect fundamentals in the short run. Nobody likes corrections or heaven forbid a market collapse but that’s part of the journey.

How to Implement:

Set a Review Schedule: Decide how often you will review your portfolio—this could be quarterly, bi-annually, or annually, depending on your needs and the nature of your investments.

Rebalancing Strategy: Establish rules for when and how you will rebalance. This might involve realigning your asset allocation to its original target or adapting it to new circumstances or insights.

Example: An investor notices that after a strong year in the stock market, their allocation to equities has risen from 60% to 70% of their portfolio, exceeding their risk comfort level. During their scheduled review, they decide to sell some of their stock holdings and purchase more bonds to return to their original allocation.

By sticking to a regular review and rebalancing schedule, you can manage your investments proactively, ensuring they remain effective and appropriate for your evolving financial landscape.

7. Thinking in Terms of Probabilities

Successful investors often shift their mindset to think in terms of probabilities rather than certainties. This approach involves assessing potential outcomes based on their likelihood and making decisions that favor the probability of positive returns over time.

Why Thinking Probabilistically is Crucial:

Better Decision Making: When you consider the probabilities of different outcomes, you’re less likely to be swayed by emotions or biased predictions. This method provides a more rational basis for investment decisions.

Risk Management: Understanding the probabilities helps in assessing risk more accurately, enabling you to make informed choices about risk-taking.

Every asset has a distribution of potential returns. Think of a normal distribution where the most likely outcome is the average or mean return for the asset class (about 10% for stocks), and the dispersion of potential outcomes is represented by the width of the distribution (standard deviation).

In a normal distribution, 2/3 of your return outcomes will be within 2 standard deviations from the mean return assumption. 99% of the outcomes will be within 3 standard deviations of the mean.

This practically means that for most asset classes, the probability of negative returns in any given year is non-trivial. Investors should expect negative returns in some years, but over time asset class returns tend to approximate their historical averages.

How to Implement This Habit:

Understand Basic Risk/Return: You don’t need a PhD in statistics to understand that the range of potential outcomes is higher in an asset class such as equities with higher average returns.

Utilize Financial Models: Many online tools and platforms offer statistical models such as Monte Carlo simulations that predict the likelihood of various investment outcomes. These can be valuable in shaping your investment strategy.

Scenario Analysis: Regularly conduct scenario analyses to understand how different situations could impact your portfolio. This helps prepare for various market conditions.

Example: An investor considering a new asset allocation might evaluate it by looking at the probability of achieving expected growth rates based on current valuation levels, potential growth rates, and risk conditions. They might decide that if there’s a 70% chance of high returns versus a 30% chance of losses, the investment aligns well with their risk tolerance.

Thinking in terms of probabilities enables you to approach investing with a more analytical mindset, enhancing your ability to achieve consistent, favorable outcomes.

8. Looking Forward, Not Back(with Regret)

Forward-thinking is a hallmark of successful investors. Mistakes are always in the back.

You can’t do anything about the past.

You can only react to what’s in front of you and plan proactively for future possibilities.

This approach ensures that you are prepared for changes in the market and can capitalize on opportunities as they arise.

Why Forward-Thinking is Important:

Evaluate Market Changes: By keeping an eye on future trends and economic forecasts, you can better position your portfolio to benefit from upcoming changes rather than merely reacting to them.

Innovative Investment Strategies: Forward-thinking allows you to consider new investment strategies and technologies that could enhance your portfolio’s performance.

How to Implement Forward-Thinking:

Stay Informed: Regularly consume financial news and insights from reliable sources. This keeps you updated on potential market shifts and innovations in finance.

Strategic Planning: Develop a strategic plan that includes long-term goals and the steps needed to achieve them. Adjust this plan as new information and trends emerge.

Networking: Engage with financial professionals and other investors to exchange ideas and perspectives. This can provide early insights into new investment trends and opportunities.

Example: A forward-thinking investor might notice early signs of change in trade policy. By adjusting their portfolio to include more investments in the economic sector most affected by the change, they position themselves to benefit from the industry’s expansion over the coming years. Renewable energy fits the bill.

Embracing a forward-looking perspective can significantly enhance your ability to manage investments effectively, keeping you one step ahead in achieving your financial goals.

9. Clearly Defining Your Measure of Financial Success

For any investor, especially those managing their own portfolios, having a clear definition of what financial success looks like is crucial. This measure should not only reflect your financial goals but also your life goals, as these are often deeply interconnected.

Why Clarity Matters:

Alignment with Personal Values: Your financial success should mirror your personal values and desired lifestyle. This ensures that your investments support your broader life goals.

Motivation and Direction: A clear definition helps keep you motivated and provides a roadmap for decision-making. It guides your investment choices and strategies.

How to Implement This Habit:

Set Specific Goals: Identify specific, measurable financial goals. These could range from achieving a certain net worth to generating a specific amount of passive income.

Integrate Life Goals: Consider how these financial goals align with your personal aspirations, such as retiring early, funding a child’s education, or pursuing a passion project.

Regular Goal Review: Periodically review your goals to ensure they still align with your changing life circumstances and values.

Example: An investor’s goal might be to build a portfolio that generates enough passive income to cover living expenses by age 65, allowing them to retire comfortably and spend more time on hobbies and travel. This clear financial benchmark directly supports their life goal of a balanced, fulfilling retirement.

By clearly defining what financial success means to you, you create a focused framework within which all your investment decisions can be made, ensuring they consistently support your overall life objectives

10. Being Kind to Yourself and Understanding Your Limits

Managing your investment portfolio is not for the faint of heart. Even professionals mess up.

Managing your investments should not come at the cost of your mental health or well-being. Remember to be kind to yourself. Acknowledge that you cannot control the markets, just as you cannot excel in every area of your life.

Understanding your limits helps in setting realistic goals and strategies that fit your comfort level and risk tolerance. It encourages a disciplined approach to investing, preventing emotional decisions driven by market highs and lows.

This self-kindness also means recognizing when to seek advice or delegate decisions to professionals, allowing you to focus on aspects of life and investing that you are more comfortable with.

By embracing your limitations, you not only safeguard your financial health but also your overall well-being, making your investment journey both sustainable and fulfilling.

Investing successfully, especially when managing your own portfolio, is not just about picking the right asset class or buying the right funds. It requires a disciplined approach and adherence to a set of proven habits that pave the way for financial growth and security.

The ten habits outlined in this note—understanding risk and return, emphasizing diversification, controlling costs, optimizing for tax efficiency, removing emotions from investing, conducting regular portfolio reviews, thinking in terms of probabilities, always looking forward, defining clear measures of financial success, and understanding your limits—are all designed to help you build a robust investment strategy.

These practices will not only improve your chances of achieving your financial goals but also align your investment actions with your broader life ambitions.

Remember, the journey to becoming a successful investor is continuous and ever-evolving. It demands persistence, ongoing learning, and an adaptable mindset.

By incorporating these habits into your investment routine, you are setting a foundation for not just surviving in the financial markets but thriving in them.

The Big Picture:

• Equities keep outperforming bonds. The dominance of US large-cap equities has been a key driver of the outperformance over the last decade.

• The big losers last week were Commodity investors in particular those with heavy oil exposure. This was a reversal from the prior week. Year to date Commodities are the best-performing asset class.

• Cash is again outperforming bonds this year. Until there is more clarity as to the direction of Fed policy this situation is likely to persist.

• The investment environment remains risk-on. Aggressive asset allocation strategies continue their outperformance. Our Risk Aversion Index is back in the Exuberant Zone.

Economy:

• While investors fret about the latest blip in US growth, the global economy remains on an upswing. Chinese growth is coming back while Europe emerges from a shallow recession.

• Loose monetary policy has helped with the expectation that the European Central Bank (ECB) will cut rates in June.

• Even in the US, where rate cuts have not yet materialized, monetary policy remains accommodative.

• The biggest global concern still concerns inflation. Part of the issue is that monetary policy can only deal with the demand side of the equation. Supply-side issues take longer to work through the system.

• Progress is, however, being made on the inflation front. The IMF estimates that by the end of 2024, US inflation will close to 2.4%.

• The IMF estimate for World inflation stands at 5.3% for 2024 coming down to 4% by the end of 2025. Much of the inflation is occurring in Emerging Market economies.

• The US has benefitted from a strong US dollar. A strong currency dampens the effects of higher import prices.

Equities:

• US Small Cap equities dominated last week with the Russell 2000 up S&P 500 up 1.6% while the S&P 500 was up 0.6%.

• Growth outperformed value once again with the S&P 500 Growth Index outperforming by 0.8% last week.

• Interestingly, two value-oriented sectors - Utilities and Real Estate - experienced the best returns last week within the S&P 500 universe of stocks. Lower interest rates on the 10-year Treasury provided a boost to these interest-sensitive sectors.

• Tech and Consumer Discretionary - two heavy growth sectors - rebounded as investors adopted a risk-on approach. Favorable earnings reports from stalwarts such as Apple, Microsoft, and Amazon fuelled the rally.

• On the downside, Energy stocks, the best-performing sector this year experienced a down week as oil prices retreated 7%. Investors believe that hostilities in the Middle East are simmering down.

Bonds:

• The Federal Reserve stood pat last week with no eminent rate cuts on the near horizon. The economy is too strong to warrant cuts at the moment. The Fed will act on an “as needed basis”, not before inflation trends down in a meaningful way.

• The Bloomberg Aggregate Bond Index (AGG) is currently experiencing its largest drawdown since its inception in 1976 in terms of both magnitude and length of time.

• The AGG is down 3.5% on an annualized basis over the last 3 years. It could be worse. The U.S. Treasury 20+ Year Bond Index (TLT) is down 11.08% on an annualized basis.

• Long-maturity Treasury bonds gained last week as long-dated interest rates came down marginally while short rates stood firm. This is in contrast to the prior week.

• Year to date the performance of short-maturity bonds has trounced the return of long-maturity bond strategies. The U.S. Treasury Short Bond Index is up 1.5% year-to-date while the U.S. Treasury 20+ Year Bond Index (TLT) is down 8%.

Signal Versus Noise

What’s Coming on Premium Wednesday😀 

• Asset Allocation Performance - Portfolio Implications

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