Interactive Investor

Three tips to becoming a smarter investor next year

29th December 2022 09:41

Stéphane Renevier from Finimize

This year has been a roller-coaster ride – bumpy enough to make even an adrenaline junky dizzy. And next year could be even wilder. So, it’s worth taking a beat here to see what we learned from 2022 and how it can help us with the ups and downs that head our way in 2023…

This year has been a roller-coaster ride – bumpy enough to make even an adrenaline junky dizzy. And next year could be even wilder. So, it’s worth taking a beat here to see what we learned from 2022 and how it can help us with the ups and downs that head our way in 2023…

Lesson #1: Expect the unexpected.

This year was full of surprises: inflation hit double-digits in much of the world, and pension fund strategies came dangerously close to busting the UK’s financial system, to name just two. In all, 2022 was a powerful reminder that unexpected stuff can happen in markets, and the environment can change really fast. And it was a reminder of the fact that there are not only known unknowns (like: what inflation will do in 2023, or how badly companies’ earnings might be hit) but also unknown unknowns (the things that could change everything but are impossible to predict).

So, approach 2023 with a healthy dose of humility. As economics professor Elroy Dimson puts it: “risk means more things can happen than will happen”. With all the crosscurrents and potential turning points out there, the range of possible scenarios that could play out in 2023 is the widest it’s been for a very long time.

In practice: don’t invest only for your base-case scenario, and make sure you understand how your portfolio might perform in other scenarios – even the more extreme ones. Finding the right balance between “maximizing your returns if you’re right” and “limiting your losses if you’re wrong” is more important than ever. Sure, there are times to “go big or go home” but, with so many uncertainties and little margin of safety embedded in market prices, right now probably isn’t one of them. But the good news is that when there’s greater volatility, there are usually greater opportunities. So make sure you’ve got some cash ready to deploy in case some opportunities unexpectedly pop up.

Lesson #2: Have a plan (for real).

If you made some investments without a clear plan regarding when you’ll sell, or what you’ll do if things get rough, you’ve probably faced some difficult decisions about what to do next. And those decisions might not have always panned out. Buying without a clearly defined plan is one of the surest ways to make costly mistakes when markets get dicey.

At a minimum, you want your investment process to answer these things: 1.) What’s your (true) time horizon? 2.) What is your return objective? 3.) What maximum loss can you tolerate – and for how long? 4.) How do you generate investment ideas? 5.) How do you assess them? 6.) Do you have a specific investment style (growth, value, momentum)? 7.) When do you buy – and not buy? 8.) When do you sell – and not sell? 9.) How do you construct your portfolio? 10.) How do you assess the main risks to your portfolio? 11.) How do you make sure your portfolio doesn’t blow up? 12.) When do you rebalance? Answering those questions isn’t as exciting as reading about the latest technology, but it’s certainly a lot more rewarding.

As legendary investor Georges Soros once said: “if investing is entertaining, if you're having fun, you're probably not making any money. Good investing is boring”. So be sure you’re covering the basics first before going after the exciting stuff.

Once you have your investment process in place, you need to make sure you respect it. And, yeah, that’s easier said than done, because as humans we’re subject to behavioral biases that can push us to make the worst decisions at the worst times (like buying at the top, or selling at the bottom).

Reducing the impact of those biases is no walk in the park, but going through these three steps should help. First, learn about the different behavioral biases (here’s a good place to start). Second, identify which ones have the strongest influence on you (lesson #3 should help). And three, have a process to limit their damage. Consider keeping a “behavioral checklist” before making any investment decision, using simple questions like “am I really respecting my investment process here?”, or “are my emotions driving my decision right now?” You might be surprised at how effective a simple checklist can be at helping you avoid the dumbest – and costliest – mistakes.

Lesson #3: Learn from the mistakes you made this year.

We’ve all made mistakes this year. That’s not necessarily a bad thing: by learning from them and refining your process, you’ll be in a better position to handle whatever comes next. So now’s a good time to review the investment decisions you made this year and think about your strengths and weaknesses. Were you overconfident? Were you over-concentrated? Did your emotions get the best of you? Did you focus too much or too little on the big-picture, or macro? Try to identify your five worst mistakes and put it all in writing: what exactly you did wrong and why, what you’ve learned from it, and how you’ll make sure it won’t happen again. Be careful not to draw too many conclusions with the benefit of hindsight, and try to focus more on the process rather than the outcome. For instance, “I was too concentrated in tech stocks relative to my risk tolerance” is better than “I shouldn’t have invested in tech stocks because they went down”.

Here’s my top tip for 2023: start keeping an investment journal. By writing a few sentences on your market views, and documenting your investment decisions, you’ll be more likely to spot patterns and identify where your weaknesses are. And that might pay off a lot more than you think, particularly as the macro environment makes investing more challenging.

Stéphane Renevier is a global markets analyst at finimize.

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