How To Put Yourself In The Top 10% Of Investors

How To Put Yourself In The Top 10% Of Investors
Stéphane Renevier, CFA

about 2 years ago5 mins

  • About 90% of retail investors end up losing money over the long term, and it’s important to figure out what they do wrong so you can do it right.

  • So set the right expectations, focus on execution, and establish a process, largely by writing down checklists and keeping notes in a journal.

  • Don’t get cocky and don’t underestimate the importance of psychology: you can be your own worst enemy.

About 90% of retail investors end up losing money over the long term, and it’s important to figure out what they do wrong so you can do it right.

So set the right expectations, focus on execution, and establish a process, largely by writing down checklists and keeping notes in a journal.

Don’t get cocky and don’t underestimate the importance of psychology: you can be your own worst enemy.

Around 90% of investors lose money in the long run, which means – and I’ve personally crunched the numbers on this – that only 10% make money. The good news is that there are a few simple things you can do to make sure you’re alongside the best of them.

Set the right expectations

Too many investors not only want to make a lot of money, they want to make it fast. But making a lot of money either requires a lot of time or a lot of risk. And even if you manage to triple one of your investments in a few weeks, you’re unlikely to repeat it over the course of a few years.

Only two things are almost guaranteed in the long term: you’ll probably make less than 10-15% a year (a return even star hedge-fund managers struggle to consistently make), and you’ll probably lose more than 50% at some point. Exceptional performance is possible, but it’ll require either luck or grit, commitment, and skill.

So write down your financial objectives (the range of returns you’re aiming to achieve), your constraints (like the maximum loss you can handle), your edge (anything in your favor that will allow you to produce superior returns), and your timeframe (how long you can realistically devote to managing your portfolio). Then make sure your objective is realistic given your constraints, and that you’re prepared to handle the losses that will undoubtedly come your way.

Establish a process

When professional investors are assessed by prospective clients, they’re judged as much on their process as on their past performance. If their process is strong, the thinking goes, the results should eventually match up.

An investment process is even more important for retail traders: it reduces the impact of your emotions, it allows you to learn from your mistakes, and it helps keep you on track when times are tough. By focusing more on the process than on the outcome, you’ll also deal better with the inherent randomness of markets.

Your investment process should at a minimum include a written description of your objectives and constraints, how you’ll generate investment ideas, how you’ll enter and exit your investments, how much you’ll risk on each position, how you’ll manage the risk in your portfolio, and how you’ll analyze your performance and learn from your mistakes. At least once a year, make time to review your process and take steps to improve it.

Don’t get cocky

Overconfidence will lead you to underestimate your risks, generate sub-par ideas, take bigger positions than you should, and significantly increase the risk you’ll end up busting your account. That matters because losses have an asymmetric impact on your profit and loss (P&L): a 50% loss will require you to make a 100% gain to break even.

Overconfidence could also lead you to overtrade, which will negatively impact your performance: trading, after all, is a negative-sum game after accounting for transaction costs and the bid-ask spread. You never want to invest solely for the fun of it.

So start an investment journal where you can document the rationale for each investment you make, along with key risks and a clearly defined plan on how and when you’ll exit the position. You can also regularly write your thoughts on markets, quantifying your views as much as possible (e.g. “I’m expecting the Fed to hike rates four times in 2022 for reasons X and Y”).

Every month or so, you should also make sure you review your journal and assess your performance objectively: how often were you right? Were you right for the wrong reasons? What can you improve next time? Actively try to poke holes in your thesis: this will either reinforce it or lead you to reassess it. Either way, you’ll be in a better place than when you started.

Focus on execution more than ideas

Sure, identifying new investment ideas is what makes investing so exciting. But what really differentiates average investors from the best is better execution.

Execution will drive how large your gains are relative to your losses (your “profit/loss ratio”), and your profit/loss ratio will drive your P&L. If you assume you’re right 50% of the time, improving your profit/loss ratio from 2:1 to 3:1 will boost your expected P&L by 50%. With a profit/loss ratio of 2:1, you’d need to increase the number of times you’re right by more than 75% to achieve the same results. The latter is arguably a lot harder to do than the former.

If you want to improve your execution, list all the potential ways of profiting from an investment view, and go with the one that minimizes costs and maximizes the potential profit/loss. That includes selecting the best asset to express a view (you could go long either oil or stocks to express a bullish view on the recovery), the best instrument (you could buy the asset itself or play it via options), the best time to enter the trade (you could buy on weakness or based on a specific catalyst), the best amount to risk on the trade, and the best time to exit.

Don’t underestimate the importance of psychology

The biggest enemy to your long-term success isn’t the market environment or the lack of investment ideas: it’s yourself.

As humans, we suffer from many behavioral biases, which will push us to take the worst decisions at the worst times – namely buying at the very top (crypto FOMO, anyone?) and selling at the bottom. A game plan might be the first step towards investment success, but the second is to make sure you respect your rules. That means not only identifying your behavioral strengths and weaknesses, but also implementing a process to limit their impact.

Start by familiarizing yourself with the main behavioral biases affecting investors. Some of my favourite books on the subject include Daniel Kahneman’s Thinking, Fast And Slow, Brent Donnelly’s Alpha Trader, and James Montier’s Behavioral Investing. Then try to assess which biases you’re most subject to – reviewing your investment journal entries should help in that regard. That way, you’ll know what to watch out for the moment they start to rear their head again, take a step back, and assess whether you’re making too hasty a move.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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