Beyond Passive

Passive index investing seems to be getting more popular by the day. And for good reason I might add. For a low cost you can get a diversified basket of stocks, a return that matches the targeted benchmark, and a lower tax bill. These are all positives when evaluating various investment options.

Now that you have found the efficient vehicle to hold your investments, the responsibility to be a good investor lies in your hands. Or should I say emotions? Even the best of investments have their downturns and higher levels of volatility. Without an investment plan to stick to, you are relying on your own behavior to get through the tough times.

Any investment should be viewed as a long-term commitment. This is the difference between investing and trading. A trader is looking for short-term gains due to market fluctuations or changes in circumstances. In the real estate world, an investor is one who looks to purchase a property and rent it out for profit over a long period of time. A trader is one who flips properties for short term profits. I’m not saying one way is better than the other, but you just need to know which one you are.

You want to put safeguards in place to protect yourself from making an emotional decision during a market downturn. This is the importance of systems, as they can take out the most challenging aspect of investing--managing your behaviors.

Have an investment policy statement. A written document that stipulates your investment process is key. This will take any question out of where to invest your money at any given time. An IPS will include your target asset allocation, a regular review schedule, and long-term objectives for your investments. In times of market volatility, you can refer back to your investment policy statement to confirm your next investment moves.

Rebalance your portfolio. There are two ways to determine how often you rebalance your portfolio back to the target allocation set forth in your IPS. One is time-based and the other is percentage-based. A time-based approach means you will rebalance your portfolio on a semi-annual or annual basis, regardless of how it is allocated at that point in time. You get in the routine of rebalancing on a specific date--your birthday or January 1st, for example. A percentage-based rebalancing process requires ongoing monitoring. You only rebalance when a specific asset has drifted from its target percentage by 10% or 20%. Let’s say your target percentage for US equities is 50%. You will rebalance when it makes up 40% or 60% of your portfolio.

Rely on evidence and ignore your gut. As you become more financially successful, you will suddenly be presented with more and more investment opportunities. Further, as the value of your investment grows, you may feel more stress in the daily fluctuations. The key to overcome this is to follow a set process for evaluating any new investment options. If you feel the need to change your current portfolio or add a new investment, go through your predetermined investment selection process to determine if it is a fit. When your colleague presents to you a can’t-miss investment opportunity, you have an easy excuse for not taking the bait. If you instead decide to only trust your gut, you will find yourself sick to your stomach every time the market takes a turn.