The Secret to Successful Investing Is Trusting the Process


To a great degree, the biggest threat to your success as an investor is you. Making investment decisions based on fear, greed, a hot tip from your brother-in-law, the headline of the day, or any of many other flawed inputs can wreak havoc on your results. What's needed instead is a trustworthy investment process.

It should be rules-based, time-tested, easy to understand and execute, and it should be one you have enough confidence in to stick with in good markets and bad.

Here are three broad types of investment processes to consider making your own.

1. DIY

You can absolutely invest on your own. The recommended process involves following traditional rules of asset allocation, using an online calculator or questionnaire to determine your optimal stock/bond mix, choosing investments accordingly (index funds that represent each desired asset class are the easiest way to go), and rebalancing annually. Or, you could choose an appropriate target-date fund, which would simplify the asset allocation process.

DIY is the least expensive investment process, but also the one that leaves you most vulnerable to emotion-driven portfolio tinkering. After all, the process I just described, whether you choose your own index funds or use a target-date fund, is essentially a buy-and-hold strategy. That means you need to have a strong enough stomach to handle the losses that will come with a bear market, trusting that the process will deliver respectable gains over the long haul. (See also: 9 Costly Mistakes DIY Investors Make)

2. DIY with help

You could subscribe to an investment newsletter that takes a rules-based approach to implementing an investment style you agree with (value, momentum, etc.). This process is DIY in that you maintain your own account at the broker of your choice and you make the trades, but it's "with help" in that the newsletter tells you exactly what to buy or sell.

This is more expensive than a pure DIY approach because you have to pay for a subscription to the newsletter (from as little as $100 to more than $1,000 per year). Newsletters typically aim to beat the market through a more active process, providing buy and sell recommendations based on objective, rules-based criteria designed to identify undervalued, high-momentum, or otherwise attractive investments. They can also better protect you from being swayed by emotion because a trusted outside authority is guiding your decisions.

3. Work with an adviser

Here the key is understanding the adviser's process. First, does he or she work as a fiduciary? That means the adviser has formally agreed to only recommend investments that are in your best interest and to disclose all fees and commissions. Next, how does he or she make investment decisions? Again, you're looking for objective rules you understand and agree with and the adviser's discipline to follow the rules.

Working with an adviser is usually the most expensive process you could employ (typically, you'll pay 1 percent of the value of the portfolio they manage for you). However, it may also provide the best protection from yourself. For one thing, a good adviser acts as a therapist during times of market stress, talking clients out of emotional buy or sell decisions. For another, the adviser typically has direct control over your portfolio; you don't. (See also: Ask These 5 Questions Before Deciding On a Financial Adviser)

Each of these processes could guide you through any market. But you have a role to play as well. Here are two ways you can tip the scales further in your favor:

Manage your expectations

The market ebbs and flows and so will the performance generated by even the best investment process. Your willingness to accept some down months, and even some down years, will go a long way toward helping you stick with your chosen process.

Having some sense of what to expect will help. If you're taking a DIY approach, you can see how various allocations have performed over the years (see Vanguard's portfolio allocation models). By the same token, you should understand how a newsletter's strategy, or an adviser's, has performed during past bull and bear markets.

While past performance won't tell you exactly how each process will perform in the future, it can help manage your expectations. That may not make riding out a downturn easy, but it should make it easier.

Tune out the noise

Adopting a trustworthy investment process will not silence the headline writers, investment analysts, or your coworkers who like to brag about their latest investment conquest. However, it should help you turn down their volume and keep you focused on following your chosen process. (See also: Want Your Investments to Do Better? Stop Watching the News)

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