You need a plan. That’s my #1 takeaway from Fidelity’s “Six Habits of Successful Investors.” One of the most common problems I come across when speaking with prospective clients of Richard C. Young & Co., Ltd., is their lack of a plan. A lot of times they own good stuff. But they don’t know how everything fits together. Picture this: You’ve set up a room full of presents, your family is anxiously awaiting by the fire, and you forgot to label the gifts. That’s how it feels to own good stuff without a plan.
The power of investing to build wealth and achieve long-term goals has been proven time and again. But not everyone takes full advantage. What separates the most successful investors from the rest?
Here are the six habits of successful investors that we’ve witnessed over the years—and how to make them work for you.
- Develop a long-term plan—and stick with it.
Tall tales about the lucky investor who hit it big on a stock idea may be entertaining. But for most people, investing isn’t about getting rich quick, or even making as much money as possible. It’s about reaching their goals – be they owning a home, sending a kid to college, or having the retirement of their dreams.
Successful investors know that means developing a plan—and sticking with it. Why does planning matter? Because it works.
A Fidelity study of 401(k) participants found that engaging in planning, either with a Fidelity representative or using one of Fidelity’s online tools, helped some people identify opportunities to improve their plans, and take action.
Roughly 30% of the people who took the time to look at their plan decided to make changes to their saving or investing strategy. The most common change was to increase savings, with an average increase of roughly 5% of pay.
A plan doesn’t have to be fancy or expensive. You can do it alone, or with the help of a financial professional or an online tool like those in Fidelity’s Planning and Guidance Center. Either way, by slowing down and focusing on your goals and making a plan, you are taking the first and most important step toward achieving them.
Tips:
- Learn more about planning. Read Viewpoints: “How a financial pro can help.”
- Build your own financial plan at Fidelity’s Planning and Guidance Center (log-in required).
- Call a Fidelity Representative for a planning session: 1-800-FIDELITY.
- Be a supersaver.
While lots of attention is paid to how much your investments earn, the most important factors that determine your financial future may be how much and how often you save.
In 2016, Fidelity completed the latest Retirement Savings Assessment, to gauge the state of America’s retirement readiness. After analyzing financial information for more than 4,500 families, Fidelity found that on average, the single most powerful change that millennials and generation X could make to improve their retirement outlooks was saving more. For workers closer to retirement, a combination of delaying retirement and saving more would have made the biggest difference, on average.1
How much should you save for retirement? Fidelity suggests putting at least 15% of your income each year, which includes any employer match, into a tax-advantaged 401(k) or IRA. “You can’t control the markets, but you can control how much you save,” says Fidelity executive vice president John Sweeney. “Saving enough, and saving consistently, are important habits to achieve long-term financial goals.”
Tips:
- To learn more about our retirement savings rules of thumb, read Viewpoints: “Retirement rules of the road.”
- Use our simple Cinch budgeting tool to corral your spending and find money to save.
- Estimate your retirement savings needs at Fidelity’s Planning & Guidance Center (Log-in required).
- Stick with stocks, despite volatility.
When the stock market tanks, it’s only human to want to run for shelter due to our inherent aversion to suffering losses. And it can certainly feel better to stop putting additional money to work in the market. But the best investors understand their time horizon, financial capacity for losses, and emotional tolerance for market ups and downs, and they maintain an allocation of stocks they can live with in good markets and bad.
Remember the financial crisis of late 2008 and early 2009, when stocks dropped nearly 50%? Selling at the top and buying at the bottom would have been ideal, but unfortunately that kind of market timing is nearly impossible. In fact, a Fidelity study of 3.9 million workplace savers found that those who stayed invested in the stock market during the downturn far outpaced those who went to the sidelines.
From the fourth quarter of 2008 through the end of 2015, investors who stayed in the markets saw their account balances—which reflected the impact of their investment choices and contributions—grow 147%. That’s twice the average 74% return of those who moved out of stocks and into cash during the fourth quarter of 2008 or first quarter of 2009.2 More than 25% of the investors who sold out of stocks during that downturn never got back into the market—missing out on all of the recovery and gains of the last seven years.
If you are tempted to move to cash when the stock market plunges, consider a more balanced, less volatile asset mix that you can stick with. Imagine two hypothetical investors—one who panicked, slashed his equity allocation from 90% to 20% during the bear markets in 2002 and 2008, and subsequently waited until the market recovered before moving his stock allocation back to a target level of 90%; and another who stayed the course during the bear markets with a 60/40 allocation of stocks and bonds.
Panic can be pricey
As you can see below, the patient 60/40 investor significantly outperformed the investor with the more aggressive 90% allocation to stocks who pulled back his equity exposure radically as the market fell.3 Assuming a $100,000 starting portfolio 20 years ago, the patient investor with the 60% stock allocation would have averaged a 7.5% return, versus 5.5% for the impatient one. In dollar terms, the difference after 20 years: $135,000.
Tips:
- Read Viewpoints: “Six strategies for volatile markets.”
- Review your portfolio at the Planning & Guidance Center (log-in required).
- If you don’t want to manage your investments day to day, consider a professionally managed account.
An old adage says that there is no free lunch in investing, meaning that if you want to increase potential returns, you have to accept more potential risk. But diversification is often said to be the exception to the rule—a free lunch that lets you improve the potential trade-off between risk and reward.
Successful investors know that diversification can help manage risk—and their own emotions. Consider the performance of three hypothetical portfolios in the wake of the 2008—2009 financial crisis: a diversified portfolio of 70% stocks, 25% bonds, and 5% short-term investments; a 100% stock portfolio; and an all-cash portfolio.
By the end of February 2009, both the all-stock and the diversified portfolios would have declined sharply (50% and 35%, respectively), while the all-cash portfolio would have risen 1.6%. Five years after the bottom, the all-stock portfolio was the clear winner—up 162%, versus 100% for the diversified portfolio and almost nothing for the cash portfolio—just 0.3%. But over a longer period—from January 2008 through February 2014— the diversified and all-stock portfolios were neck-and-neck: up 30% and 32%, respectively.
This is what diversification is about. It will not maximize gains in rising stock markets, but it can capture a substantial portion of the gains over the longer term with less volatility than just investing in stocks. That smoother ride will likely make it easier for you to stay the course when the market shakes, rattles, and rolls.
A good habit is to diversify among stocks, bonds, and cash, but also within those categories and among investment types. Diversification cannot guarantee gains, or that you won’t experience a loss, but does aim to provide a reasonable trade-off of risk and reward for your personal situation. On the stock front, consider diversifying across regions, sectors, investment styles—value and growth—and size—small, mid- and large-cap stocks. On the bond front, consider diversifying across different credit qualities, maturities, and issuers.
Tips:
- Read Viewpoints: “Pros’ guide to diversification.”
- Review your portfolio with the Guided Portfolio Summary (log-in required).
- Research asset allocation mutual funds and exchange-traded funds (ETFs), which can provide easy diversification.
- Buy low-fee investment products that offer good value.
Savvy investors know they can’t control the market—or even the success of the fund managers they choose. What they can control is costs. A Fidelity research study of large-cap U.S. funds from 1992 to 2015 found that simply filtering for the 25% of active funds with the lowest cost among the five largest fund families produced a set of funds that beat the market by an average of 0.18 percentage points annually, and outperformed their peers by an average of 0.89 percentage points annually.4
That may not sound like much, but over time it really adds up. Earning an additional 0.89 percentage points per year over the past 20 years on a $10,000 investment, compounded annually, would earn an additional $7,100.
Filtering index funds for lower fees and fund size also identified a set of funds with an average performance superior to the overall average for a passive fund—by an average 0.32 percentage points over its peers from 1992 to 2015 (although still underperforming the market net of fees). On a $10,000 investment, compounded annually, that extra 0.32 percentage points a year would add up to an additional $2,588 over the past 20 years.
Using different filters would lead to different outcomes, and not all funds deliver similar performance or value. So it is critical to be selective when choosing investments.
Tips:
- Read Viewpoints: “How to find better-performing funds.”
- Research funds and ETFs.
- Focus on generating after-tax returns.
While investors may spend a lot of time thinking about what parts of the market to invest in, successful investors know that’s not the end of the story. They focus not just on what they make, but what they keep after taxes. That’s why it is important to consider the investment account type and the tax characteristics of the investments that you have.
Accounts that offer tax benefits, like 401(k)s, IRAs, and certain annuities, can play an important role in generating after-tax returns. Think about “account location”—how much of your money to put into different types of accounts, based on their respective tax treatment. Then consider “asset location”—which type of investments you keep in each account, based on the tax efficiency of the investment and the tax treatment of the account type. Consider putting the least tax-efficient investments (for example, taxable bonds whose interest payments are taxed at relatively high ordinary income tax rates) in tax-deferred accounts like 401(k)s and IRAs. Put more tax-efficient ones (low-turnover funds like index funds or ETFs, and municipal bonds, where interest is typically free from federal income tax) in taxable accounts.
Tips:
- Read Viewpoints: “How to invest tax-efficiently” and “Why asset location matters.”
- Understand your IRA options.
- Research low-cost annuities.
The bottom line
There is a lot of complexity in the financial world, but some of the most important habits of successful investors are pretty simple. If you build a smart plan and stick with it, save enough, make reasonable investment choices, and beware of taxes, you will have adopted some of the key traits that may lead to investing success.
