How to Succeed as an Active Passive Investor—Part One

by | Nov 4, 2013 | *Financial Awakenings, Building Wealth, Fee Only Financial Planning, Investment, Weekly Column

WateringMoneyTreeA fundamental principle I preach is that having a core of passively managed mutual funds is the foundation of successful long-term wealth building. I practice that principle, as well: about 75% of the securities in my personal portfolio are passively selected. My commitment to this approach has evolved both from my own years of investing experience and from reading reams of research. I’m convinced that “beating the market” over the long term is as elusive a goal as capturing a wild jackalope.

Does that mean investing is as simple as giving most of your money to passive managers and kicking back? Not quite. Yes, investing in the index funds of a diversified group of asset classes and leaving them alone is a good fundamental strategy that will help you secure your financial future. To be even more successful, however, it helps to actively apply some additional strategies.

I was reminded of this by a June 2013 blog post from Bob Seawright of Madison Avenue Securities. Here, inspired by and adapted from his “top ten” list, are some of the factors that strongly affect the success of passive investors. While financial professionals can help with all of these strategies, investors going it alone can also benefit from paying attention to them.

1. What’s the point? A successful investment strategy starts with establishing clear, objective, and realistic goals. Most people bypass this step, thinking it is unrelated to their investment selection. Yet very few people on their deathbeds focus on how great it was to get a 7% annual return on their investments. Drilling down to what is really important in your life is no simple task, but it is essential. Creating a life worth living means using portfolio returns to support your dreams and desires. Knowing where you are going and why is the first step to establishing a successful portfolio.

2. A written investment plan. Yes, you need your investment strategy in writing. This both insures that you have one and helps you clarify it. I find that writing things down often helps me find gaps and inconsistencies in what I thought was a complete and rational plan.

A written investment plan should state:
a. Your investment philosophy. Are you a passive or active investor, or both?
b. Your goals and objectives for your funds. This answers the question, “How and when will this money support my life?”
c. Guidelines and constraints you will adhere to in managing your money. What tenure do you want in a manager, what is your upper limit on expense ratios, how much flexibility will you give a manager, what quantifiable factors will take you out of a market or bring you back in?
A written plan will bring structure and discipline to your investment strategy, qualities most investors lack.

3. Manage your behavior. We all have blind spots, biases, and delusions. How you behave in the face of market declines and advances will affect your long-term portfolio returns more than any other single factor. To make this even more challenging, your brain is naturally wired for investment failure. Identifying and reframing your money scripts can help you rewire your brain for success instead. Working with a financial coach or therapist can be invaluable to help you negotiate your own mind.

4. Financial planning. Many people think financial planning is limited to investment advice. Yet it is much broader and deeper. Financial planning not only helps you build wealth, but helps you use it wisely to support the life you want.

Six more keys to successful passive investing are covered in next week’s column.

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