The “Smart” Investor

When News Strikes How Does “The Smart Money” React?

I get incredibly excited when one of my clients decides to begin investing. The biggest eye opener for these new investors? People tell me over and over that they can’t believe investing doesn’t require nearly the skill or persistence that it takes to become great in the arts. It’s difficult to become a painter, a sculptor or an actor. An investor? Actually not that hard at all.

When people begin investing, one of their first questions is always about the “smart” investor. What are those incredible moves that “they” make that the rest of us miss?

This seems like an especially important question now, with all of the swirling news around the world. Between the government shutdown, debt ceiling fight, Syria problems, Twitter initial public offering (called an IPO) and horrible shootings, there’s plenty of news in the world. I’m sure between the time I’ve written this and when it actually hits our blog there have been five or six “big” pieces of news.

First, here’s what the “smart money” doesn’t do when there’s news:

Smart money doesn’t react.  Smart investors play statistics. Like a casino knows that over longer periods the odds will make them a winner, so does an intelligent investor. Stocks, for example, are incredibly volatile over the short run. Your returns could be really high or extremely low if you only invest for six months or a year. When you move the camera back and examine longer periods, such as 10 and 20 years, stocks are fantastic investments. In fact, if you purchase a diversified, large company mutual fund or exchange traded fund, you would have only lost money on rare occasions. Because of this, smart investors stick to long term strategies.

Over the short run, news doesn’t give the smart investor opportunities….unless you know what the news is going to be (and if you do, trading on this information could be illegal!). If it weren’t for news, the stock market would be a much less volatile place. Therefore, a smart investor knows not to trade based on news.

In the rare occasion that an intelligent investor decides to break this rule and make a trade based on news, they don’t do it in the manner most investors would expect. When calamities strike, the average investor tries to protect capital by selling to cash. This doesn’t make sense to great investors. Instead, these intelligent investors ask, “Is this an opportunity for me to purchase more quality stuff at a lower price?” While everyone else is running for the exits in a panic, the smart money is quietly searching through the fire sale for good positions they can pick up at a cheap price.

Generally, though, the “smart” investor doesn’t trade at all on news.

Here’s how intelligent investors trade:

They buy stocks with the intention of holding them long term. Unless they need the money, the plan is to never sell. This cuts down on fees and taxes from buying and selling, which they know can be a huge drain on returns.

Intelligent investors pay attention to the amount of money they have in each single position. When they have too much, they reallocate their funds to remain well diversified. Selling the excess of over-allocated stocks and using the money to purchase more shares where you don’t have a large enough position is referred to as “rebalancing” a portfolio.

Smart investors pay as much attention to the type of account they hold as to the individual holding. If they have a 401k plan, they know they can stuff money away on a pretax basis. This means they won’t pay tax on the money until they sell. If the company matches their contributions that’s fantastic, but a smart investor knows this is just “icing on the cake.”  The real win is by investing with pretax money.

If they don’t have access to a 401k plan, they know that they may be able to deduct a traditional IRA or contribute to a Roth IRA where money grows tax free. By holding investments in tax shelters, the smart investor is able to grow money faster than someone who only worries about picking the right funds.

Intelligent investors know that saving money is a huge part of winning with investments.  Therefore, they set up automatic investment strategies to keep dollars flowing toward their future plans. This is great news because even in those years when financial markets decline, the smart investor is still moving closer to their long term goals.

As you can see, the smart investor finds news largely irrelevant at best and a hindrance at worst. Rather than reacting to the daily grind of “something new happened,” they focus instead on their goals, tax situation, and their ability to invest dollars on a consistent basis.  Isn’t it interesting that if you watch financial news, you wouldn’t think this is the case? You’d instead think that buying and selling constantly, paying attention to news and loading up on single positions is the key to success. Maybe that’s why there are so few “smart money” investors out there!

2013-10-18T09:00:54+00:00