Although many authors try to boil down investment advice to the generic and claim it's "one size fits all", here at DQYDJ we believe that there are many types of investors. You can fit all of these types of investors into four main categories, however, depending on their emotions and the amount of information they are willing to find or research.
The (Main) Four Types of Investors
There are four main, overarching types of investors... and the many subtypes can all fit into one of these buckets (or, hey, may pull from multiple buckets):
- High Information/High Emotion
- High Information/Low Emotion
- Low Information/High Emotion
- Low Information/Low Emotion
Here's how they break down:
- High Information / High Emotion: You're the kind of investor who pours through the research, has read all the books, digests as much as you can read on the internet and studies the financial reports. However, when it comes time to trade you can be too quick with the trigger - a glance at your trading history reveals panic sells, piling into rising stocks, and maybe some brief flirtations with momentum investing and technical analysis (likely with poor results). Basically, you know a lot about the market but your emotions get the better of you on the transaction side.
- High Information / Low Emotion: Like the HI/HE investor type, you devour all the information that exists on stocks and valuations and alternative investments. You can hold court in any conversation about investing strategies and know your way around a balance sheet. Unlike your HI/HE buddy however, you are very deliberate when it comes to buying and selling - only making moves when you can verify something using certain valuations and never selling based on emotions. The downside? Sometimes you are too slow to react.
- Low Information / High Emotion: You get most of your investment ideas through conversations with friends, tips heard at various places of business, and by reading "Top 10 Lists" of stocks. You're very into the stock market, but don't know much about valuation, hedging, and probably wouldn't be able to keep up on an analyst call. However, you care deeply about retirement, tend to have certain parts of your portfolio tank, and are quick to want to move to cash in a downturn. This is the most dangerous investor archetype, but if you recognize yourself in these traits you can work around it.
- Low Information / Low Emotion: You don't know much about the stock market, mutual funds, or securities... and the funny thing is you don't care much. You may or many not participate in a 401(k), but you can't tell a Roth IRA from a 529 (and will walk away from someone trying to ask about them). This type of investor is the type to say "I haven't looked at my portfolio in a while".
Did you identify yourself there?
Find which of the four types of investors you best fit with, because it makes a huge difference to the investments you should pick. From my anecdotal experience, I would say that most people in the general public fall into category 3, Low Information/High Emotion investors - and that's fine, if you recognize it.
They worry lots about having a retirement when they are too old or sick of working, but they are much better at their day jobs than investing. None of these categories are meant as an insult - the truth is, for LI investors, you probably made a conscious or subconscious decision to not increase your financial knowledge. For most people, it's not a stretch to say they should stick to index funds and target date funds and concentrate on their careers.
"You're Unique. Just Like Everyone Else."
Here's the point of that little exercise:
"Different Investors Require Different Approaches While Investing." -PK
You've now categorized yourself in one of the four categories above, or at least found the category which is closest to describing you. Now you can figure out the general style of investing which is right for you.
- Low Information / Low Emotion: If you can't light a fire under yourself, you should at least try to get inspired long enough to make sure you're getting all of the investment perks available to you through work: 401(k)s, Stock Purchase Programs, Share Grants, Options, and all other forms of 'free money'. Ask a trusted, smart coworker (or if your plan comes with advice, ask there) where to put your allocations. Also look at Roth and Traditional IRAs.Thanks for reading - we'll see you in ten years when you've amassed a lot of money, your career is on cruise control, and are curious about the next step! You'll be fine.
- Low Information / High Emotion: First off, try not to worry too much about the general ups and down of the market, your real estate, and mutual funds and bonds. If there is a total 100% drop in a huge asset class like the stock market we've got bigger problems than our retirement savings.For you, you're best off putting some layer of separation between you and your funds. Consider a Financial Adviser or a passive strategy and a simple portfolio with some sort of stock/bond mix. Buy and hold is usually a good option for an investor like you. Try not to worry too much about volatility - the market may lose money but it historically comes back!
- High Information / High Emotion: Congratulations! You have what it takes to delve into investing a little deeper; you just need to keep your emotions in check. Use your considerable knowledge of valuations to determine a good investment mix for yourself. Think seriously about avoiding individual stocks or options - know that while your knowledge is considerable, you should use some mechanical system to choose your entry and exit points.Stop losses (trailing or otherwise), limit orders, and certain option trading strategies are perfect for you - just try to keep your itchy trigger finger on your mouse away from the buy/sell screen on your brokerage window! If you can't? Stay away from individual stock and bonds. You can still apply your knowledge to other forms of investments...
- High Information / Low Emotion: Call it what you will, but you know this personality type when you see it - smart and indifferent. If you find yourself in this category? Congratulations. You're in the one percent of investors who have the stomach to really swing for the fences.You're emotionally and strategically set up to be a good investor. Your biggest issue is cockiness - you might have an track record which looks good, but if you blow up you'll tend to blow up hard. Limit your bet sizes, watch your arrogance while trading, and always keep learning. Of all the classes it's most important that you never get stuck with certain biases... always keep reading and absorbing new information into your repertoire while investing.
For Most, Passive Buy and Hold in Index Funds and Target Dates Funds is Best
Isn't it crazy the diversity in personalities represented in the stock market? We should all see ourselves in the above types of investors - and you'll probably find yourself gravitating towards one of the types most of all.
If you sorted yourself into either of the low information categories?
I would suggest sticking to buy and hold principles. If you dabble too much in speculative investments or individual stocks and bonds (or worse, IPOs, futures, derivatives and options!) you'll quickly find yourself falling behind the curve financially. Remember: on a long time frame, say over a 30-40 year career, stocks have almost always outperformed bonds. You'll be okay even if you give up a little bit of that maximum return and avoid big losses due to timing and churn. Just make more by concentrating on your career, okay?
If you sorted yourself into the high information categories?
The odds are, yes, you can probably optimize your portfolio to a high degree - and potentially achieve better returns than you are receiving currently. For a high information investor who is willing to put in the work, look to Warren Buffett (duh), Ed Thorp, Peter Lynch, Ben Graham, David Dodd, Irving Kahn, and Walter Schloss. Heck, even Bill Gross. We get into that - and the Efficient Market Hypothesis - in other posts on this site.
Which one of the types of investors are you? Do you agree with my assessments? What sort of things do you do to cover for your weaknesses?