WHEN it comes to habits, you’d be surprised at how sticky they can become. A chemical called dopamine, known for being related to pleasure, plays an important role in the formation of your habits.
If the chemical is activated repeatedly, habits can become so ingrained in your psyche that they can be tough to shed.
While this may be a problem for bad habits, it also means that once you adopt a good habit, it feels natural to carry on practising it.
For investing, it’s useful to develop good habits early on so that you will not only make fewer mistakes but also make your investment process much more efficient.
Here are six habits that can make you a more effective investor.
1. Invest as early as you can.
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Scientist Albert Einstein, one of the most influential physicists of his time, remarked that “compound interest is the eighth wonder of the world”. He understood the power of this concept in creating wealth for those who could harness it.
By investing early, you can compound your money over many more years to achieve a much larger sum as compared to someone who started later.
A simple example illustrates this point. Imagine a lady called Anne who graduates from university and starts investing S$5,000 at age 25. She then continues to add S$2,500 a year for the next 40 years and her money earns an average annual return of 7 per cent.
Contrast this with Richard, who waited till he was 35 years of age before investing S$10,000, double the initial sum that Anne invested. As he had built up a larger pool of savings, he proceeded to invest S$5,000 per year over the next three decades till he reached 65.
If we also assume the same 7 per cent annual return for Richard, you’d surprised to learn that Anne ends up with more money than Richard when both reach 65. For those who relish the maths, Anne will end up with close to S$609,000 while Richard’s pool of money will grow to around S$581,500.
Starting early and getting into the habit of investing regularly can let compounding work wonders for your portfolio.
2. Drill down to what is important
It can be tough to filter out the cacophony of talking heads that appear on TV and in the news daily. The din can make you lose track of what’s important when you invest. Ultimately, opinions are just educated guesses on a subject.
To understand what is going on, you should focus on the earnings, cash flow and prospects of every business that you invest in. These are the fundamentals of the stock you park your money in.
If you’re a dividend investor, then you should turn your attention to the cash flows that a business generates. If you seek growth, then you should follow the company’s plans, study its industry, and find out how it intends to chart its path forward.
Regularly following the business instead of the news will make you a better-informed investor with each passing day.
3. Maintain a long-term view
As the saying goes, Rome wasn’t built in a day. For your investments to do well, you need to have patience as great businesses take time to grow their revenue and profits. As such, having a suitably long time horizon is necessary to allow compounding to work its magic.
In the short term, there may be significant volatility in share prices as they are affected by all manner of sentiment and macroeconomic events. Such fluctuations should be taken as the norm rather than the exception.
Trading in and out of stocks not only incurs significant brokerage costs but also detracts you from your goal of building a comfortable nest egg for retirement.
The key to becoming rich is to park your money in solid, resilient businesses that you can be certain will be around 40 to 50 years from today. Form the habit of patience to ensure you can patiently wait for your investments to bear fruit
4. Reinvest your dividends or capital gains
Receiving a dividend is always a great feeling. While it is perfectly acceptable to spend a portion of your dividends on a hearty meal or a holiday, you should consider reinvesting the rest.
By buying the very same stocks that paid you these dividends, you can accelerate the compounding process to receive even more dividends the next time they are declared.
The same process can be practised with capital gains, too. Reinvest the money that you receive from selling stocks by allocating them to other promising names.
By consistently reinvesting your money, you will see your pot of money grow much more rapidly.
5. Stick to an investment plan
Investing without a plan is a little like shooting ducks in a carnival while wearing a blindfold. You may occasionally get lucky but more often, you end up completely missing your target. It is, therefore, important to sit down and draft an investment plan with guidelines as to how you should invest and what you should invest in.
An investment plan also consists of goals that you set for the particular life stage you are at. A young man who just started his first job may wish to focus on growing his money through growth stocks. He may also allocate a fixed sum into the market through a dollar-cost-averaging strategy.
Contrast this with someone from the sandwich generation who needs a mix of growth and dividends and can only invest on an ad-hoc basis.
As each of us has different objectives, writing them down and adhering to them will ensure you do not veer off track when investing. Make it a habit to periodically check on your plan and update your goals to make sure you are on track.
6. Take care of your downside
A common mistake in investing is to focus too much on your upside and to ignore or downplay the risks. All investments carry risk and you should assess how comfortable you are in owning a stock before you pull the trigger.
If there are areas where you feel uncertain or uncomfortable, it’s perfectly all right to move on to another investment. Too many investors end up chasing the rewards without factoring in the risks involved to attain these rewards. But it’s also impossible to completely avoid losses as unexpected events may crop up.
Losing money occasionally is normal. Even veteran investor Warren Buffett makes mistakes and loses money on some of his investments. The key is to avoid a big loss that will sink you into a financial hole that is tough to recover from.
Hence, you need to habitually check for any risks, blind spots or red flags that could trip you up.
By adopting these useful habits and making them part of your investment process, I guarantee that you can become a much more effective investor.
The writer does not own shares in any of the companies mentioned. He is portfolio manager of The Smart Investor, a website that aims to help people invest smartly by providing investor education, stock commentary and market coverage
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