“Know Thyself” was the famous mantra of the ancient Greek philosopher Socrates.
Socrates’ advice has resonated down through the ages. It is as important to know yourself — understand your impulses, tendencies, and fears as an investor as in any other area of life.
Maybe you’ve started to dip your toes in the shark-infested waters of the markets and are a bit nervous about venturing too far out. Or maybe you jumped in with both feet, swam out beyond the breakwater and got bit real bad — and lost all your money. And now you’re too scared to get back out there.
And so on the shore you sit, wistfully watching the other players riding wave after wave of profits in the longest bull market in stock market history.
Or maybe you’re wanting to get started investing, but have felt paralyzed by the overwhelming number of options out there. There’s so much to learn and study — it seems- that it’s easier to not get started at all. I get that.
The place to start is to understand your investing “type”.
I’ve learned over the 25 or so years I’ve been investing that there are definite investing personalities or temperaments. Each have different risk/reward profiles, different time and training requirements, and each employ different strategies to reduce risk.
In order to be successful, it is key that you know who you are as an investor. When you know your “type” it is much easier to narrow down your focus to a style of investing that you will be comfortable with, and most importantly, successful at.
So without further ado, here is my take on the three main investor types:
Type #1. Lightening in a Bottle (aka The Speculator)
This type of investor embraces risk. Loves the adrenaline rush of high-risk, high reward speculation. Short-term day traders fall into this category, as do options traders, commodities and currency traders, penny stock devotees, and momentum investors.
I think the particular danger in this type of investing is when greed is at the forefront of our motivation. There is no shortage of self-appointed stock market gurus out there, stoking our greed instinct by promising 89% a day in profits.
Or options traders selling their secret systems to “life changing” wealth.
Confession: I started my investing journey as a Speculator. I got sucked into one of these too-good-to-be-true systems that promised anyone could learn to trade commodities successfully. (Which, though technically true, most people — including me- end up losing their shirts before figuring out how to win.)
Long story short, I lost about 20K in 3 months trading things like corn and soybean futures, and Japanese yen. Lol. I only share this humiliation in hopes that my youthful folly saves you from going down this road.
Now, where I got the 20k to start out as a promiscuous commodities trader is a story for another day. Suffice to say: easy come, easy go.
I have recently come back to speculating in things like penny cannabis stocks, microcaps, and even some bitcoin. But, I’m careful to only risk a small portion of my holdings in these stocks, and I have clearly defined exit strategies.
If you decide to venture down this path, then I recommend you study up and paper-trade for a while before putting down any money.
Type #2. Three-toed Sloth (aka The Passive Investor)
The main characteristic of this type of investor is laziness.
Now, don’t misunderstand. The lazy, passive investor is a very good and profitable thing to be. In fact, the lazier you are, the more successful you are likely to be. This type of investor buys index funds and holds bonds long-term. Robo-investors are also in this category.
Index funds track a specific market sector. Rather than having to identify individual winners and avoid losers, you buy a fund or ETF that mirrors the asset class, or sector of that class.
For example, Vanguard’s VTSAX fund provides exposure to the entire universe of U.S. stocks, for the bargain basement price of 0.04%. In 2019, this fund returned 30.8%, virtually the same as the stock market itself.
The bulk of my investment portfolio is in passive index funds. I allocate 45% to a variety of index funds that have historically slightly outperformed the S&P 500. I allocate 28% to a variety of income-generating assets like bonds, and REITs (Real Estate Investment trusts). The remaining 27% is allocated to index funds that target specific market sectors, such as healthcare stocks, or tech growth stocks, or emerging markets such as Brazil.
The latest trend in passive investing is what’s known as Robo-Investing.
So-called Robo-advisors are computer automated investment platforms. Using computer algorithms optimized for your age, retirement goals, and risk tolerance, the “Robo-advisor” will put together an optimal portfolio tailored to you, and automatically manage it to stay on track over time.
They typically cost less and offer more than a traditional investment advisor, but remove the one-on-one human element from the equation. This leads to more objective and lower-cost investment decisions, which is great for investors of all backgrounds.
Type #3. Bargain Hunter (aka The Value Investor)
You have probably heard the name Warren Buffet. The most iconic, most beloved, and arguably most successful investor of our time. Investors the world overhang on his every word. Thousands show up at the annual shareholder meeting for his company Berkshire Hathaway.
Buffet is the quintessential value investor. His widely-quoted mantra is “Be fearful when others are greedy, and be greedy when others are fearful.”
He doesn’t go for sexy. He buys solid, well-run businesses that he understands. Banks, insurance companies, utilities, railroads and the like.
Here’s what matters most: he only buys great companies, and only when they go on sale.
I am by nature a bargain hunter. I love buying a great product or service at a steep discount. Therefore, when I come across a company that I love and see it priced well below what I think it should be priced, I can hardly restrain myself.
To be honest, value stocks are my weakness. I love the idea of being part owner of a great company like Apple or Cisco or Wells Fargo. But I can get so carried away with trying to gobble up all the juicy bargains that I lose sight of my overall investment strategy. Also, owning too many individual stocks can be hard to keep on top of.
How Risky Do You Want Your Business?
Part of Knowing Thyself is understanding your appetite for risk.
All investing involves risk. Obviously, speculating in bitcoin and pork bellies is risky. Buying solid, blue-chip companies that are trading at a discount and pay a solid dividend is less risky.
But investing too conservatively or not investing at all is also a risk. The possibility that you might run out of money when you’re too old to make more is real.
Can you stomach the idea of your portfolio losing up to half its value in a severe market downturn?
(By the way, this is where being an *extremely* lazy investor is most beneficial. I mean lazy to the point where you set your contributions on automatic pilot into an all-stock index fund and check on your account once every 10 years or so. You could self-induce into a coma and wake up 20 years later, and most likely you will be *extremely* pleased with the balance of your portfolio.)
If you’re like most people, though, you won’t be able to resist checking on your investments regularly, and will find it difficult, if not impossible, to stand by and watch as your hard-earned nest egg drops like a rock.
In that case, you may want to consider a more balanced portfolio by diversifying into different asset classes that tend to move in different directions than the stock market. Assets that zig when others zag.
Risk is a too complicated subject to explore in-depth here. But it’s a critical aspect to consider — no matter what type of investor you are.
Lightening in a Bottle investing is inherently risky, but those with the right temperament and analytical and trading skills can do very well. They know how to significantly mitigate risk.
Three-toed Sloth investing can have varying levels of risk too, depending on the mix of assets you choose.
Same goes with Bargain Hunter investing. Sometimes stocks are on sale for a good reason, and if you don’t spot the reason, you’re at risk.
Why You Should Start Out As a Sloth
Whatever your risk threshold, I highly recommend every person new to investing start out as a Three-toed Sloth and buy index funds.
I started out as Lightening in a Bottle, and that didn’t turn out so well. Then, I was for many years a Three-toed Sloth. I have slowly morphed over time into a comfortable blend of all three, though still maintaining my primary identity as a Sloth.
Beginning as a Sloth is a simple, highly-effective, low-cost way to broadly diversify across a wide range of different asset classes, allowing you to get started on your investing journey with little effort or skills.
Once you’ve set up a foundation portfolio of index funds, and the idea of embracing more risk — and potentially achieving higher rewards — appeals to you, you might want to consider learning about options trading.
Or, if you’re a bargain-hunter by nature, you may want to branch out into learning about how to find those hidden under-valued gems, or explore investing in dividend growth stocks.
The truth is, most investors will get the best results from sticking with Three-toed Sloth investing.
So you can forget about your investments and just go fishing.
Alternatively, you can go Ultra-Sloth and sign up with a Robo-Advisor, such as Betterment or M1 Finance. You’ll pay a little bit more, but the ease and peace of mind that your portfolio is being expertly managed may be well worth it.
Because really, the most important thing is to just get started. The longer your dollars are at work in the market producing even more dollars, the less you will have to eventually save to reach your goals.