One of the most important questions we all should have to answer. What kind of investor am I? This question is so important because without knowing what kind of investor you are it is impossible to evaluate your investment results or properly answer the question, How am I doing?
While it is important to understand your personal risk preference (conservative, moderate or aggressive) this is not what I mean when I ask the question, What kind of investor are you?
Here are some examples of the types of investors that you could be: income investor, accumulation investor, alpha investor, smart beta investor, contrarian, long term growth, day trader, indexed arbitrage investor, and much more.
With so many different categories of investors how do you choose which approach is best for you.
To figure out what kind of investor you should be here are four questions you need to ask yourself.
- What are my goals? The investment style you choose should match your personal goals first. These goals may be in terms of total dollars you want to have by a certain date, it could be based on income need or lifestyle choice.
- What is my risk tolerance? While it is not the main reason for choosing an investment style, it certainly is a factor in how you will approach implementing your investment style.
- What resources do I have and need to be financially secure? While you may want to be a day trader. While you may think of yourself as an aggressive investor. If you can’t afford to live through the volatility this type of approach generates then maybe you should choose an investment style better suited for your financial situation.
- What can I emotionally handle? Can you live through a 30% loss in order to realize an 8% average return? Maybe you can intellectually but when you actually see your accounts go down by 30% will you stick to your approach or sell out only to lock in your losses and never recover.
Regardless of which approach is right for you at some point your investments and your investment style will be in favor and at other times it will not. This is just how the world works. And here is where the problems begin.
For some reason that is out of your control, your investment style is out of favor for the moment and another investment approach is hitting new highs or is being touted as where you need to be right now. So you quickly change your investments and sit back believing you have solved all your financial problems.
If you have ever studied behavioral economics or seen the DALBAR report about 401(k) investors you will realize this is the main reason most investors never achieve their financial goals. It is possibly the worst thing you can do. The reason is very simple. Wait another six months to a year and your new investment style will be out of favor and your old investment style will be what everyone is talking about.
Examples of this are everywhere. In 2007, if you weren’t an aggressive investor you were missing out on the bull market. In 2008, if you weren’t a conservative investor seeking smart beta or income then you were down 50%. In the late 1990s, if you weren’t buying the next great tech. company that never made a profit then you were missing out on making millions. But from 2001-2003, if you were in tech, you experienced the worst multi-year decline we have seen in many decades.
This is why keeping perspective, understanding your goals and managing your expectations are key to financial security.