Dividend Value Builder Newsletter
3 Types of Investors – Which Type Are You?
I see 3 main types of investors today; each with their own characteristics and results. The first lets their emotions cause them to make really bad investment decisions; usually these people eventually quit. The second voluntarily decides the best they can achieve is average performance, with the result being good results in bull markets and poor results in bear markets. The third type of investors attempt to control their emotions and increase allocations when asset valuations are bargains and decrease allocations when asset valuations are high.
Let’s look at the 3 types of investors:
The Buy High, Sell Low Investor
Many investors find themselves buying when everyone else is buying and selling when everyone else is selling. It’s imbedded in our culture; including momentum investing. It’s embedded in our DNA; we like to be validated by other people’s actions. This is represented by the investor who listens to the media, culture, and lets their emotions cause them to make bad decisions.
This result is these investors far underperform the market averages because they buy at above average prices and sell at below average prices. In other words they buy high and sell low.
Often these people become disillusioned, and some even bitter, believing the market is rigged when it was actually their own doing. Most often these people either quit or eventually lose much of their money.
The Index Investor – Passive Management
This is the most popular and universally accepted type of investing strategy. The index investor believes he can passively invest money in funds that follow indices and receive a “fair” or average rate of return.
Index investing became very popular in the long bull market from 1980 – 2000. Its current acceptance has become a cult-like strategy that draws criticism to its critics and contempt towards those who speak out against this favored investing strategy.
Index investing does very well in bull markets and very poorly in bear markets. I call this “lazy investing” although most investors have truly been misled that this is the best way to invest. Passive management produces average rates of return less expenses and fees.
Index investing is best for investors who lack the time, knowledge, or desire to invest time and effort into individual investment opportunities. There is nothing wrong with this choice, but it is a choice.
The Value Investing Investor
The Value Investor attempts to buy investment assets far enough below their intrinsic value as to provide a margin of safety. This requires hard work, research, and an ability to not let the culture tell you what to do. Therefore it is more difficult than it might appear.
Intrinsic Value and It’s Relationship to Margin of Safety
The fact is most bear markets are preceded by excessive valuations. Most bull markets are preceded by bargain valuations. That is why investors need to have a flexible asset allocation that allows them to change their allocations based on the probability of success.
Value investing should not be confused with market timing. Some investors make investment allocation decisions based on charts, momentum, or various market indicators. This is called market timing.
Value investors make allocation decisions based on price and value. Some of us call this valuation timing. Purchasing assets for less than their real worth lowers risk and increases the probability of higher than average returns. It also makes sense that purchasing assets for more than their real worth increases risk and decreases the probability of lower than average rates of return.
Which Type of Investor Are You?
Every investor should make a conscious choice in what type of investor they choose to be. Obviously, no one wants to be a buy high, sell low investor. Some investors make a rational decision to be an index investor due to their circumstances.
However, if you have the time and inclination, the market averages can be beaten! You can lower your risk by purchasing assets that are undervalued and selling assets when they become overpriced.
If you are inclined toward value investing this blog has many resources from which to learn:
10 Investing Principles Fundamental to Successful Outcomes
Minimize Large Portfolio Drawdowns
Invest With Confidence in Less Time - Manage Your Portfolio Without Behavioral Errors