What Type of Investor Do You Want to Be?

The text below is provided for informational purposes only. It is not investment advice; you must do your own due diligence before making any investments. By reading beyond this point, you agree to hold the owner of this website harmless for your investment decisions.

One main question is whether you want to be an active or a passive investor.  Warren Buffett says that most people, 98-99%, should be passive investors.  They should put their money into low-cost stock and bond index funds, which follow the market, rather than trying to pick individual stocks and bonds.  You do not need to beat the market to be a successful investor.  You will do well in the long-run by just following it.  To be an active investor, you need to be willing to put in the time and effort to identify and research investments that will do better than average.  Most people do not have the time nor the interest to do that type of research.

Still, it is very tempting to think that you should be able to divide stocks into “above average” and “below average”.  By ranking stocks based on long-term potential for growth, you should be able to pick 10-30 stocks that provide enough diversification and beat the stock market average.  It takes work and discipline to achieve that goal.

You do not necessarily have to be in one camp or the other.  The Bear puts a large part of his money (around 40-50%) into low-cost index funds, but sets aside a portion (another 20-25%) for picking individual stocks.  My reason is that I treat stock picking as a hobby and enjoy the research it requires.  The remaining money (around 35%) goes into low-cost bond funds. 

Note:  The Bear is not recommending any specific allocation between stock index funds, individual stocks, and bonds.  The allocation described above is just for informational purposes and will change as circumstances dictate.

The second main question concerns your risk tolerance.  Stocks are generally more volatile than bonds and will decline more during a recession or market correction.  Being less volatile, bonds help to stabilize your portfolio.  On the other hand, stocks tend to do better than bonds over a long period of time. So, your asset allocation between stocks and bonds depends on your ability to withstand losses in the event of a market downturn and whether you have enough time to recover from losses.  Factors to consider include your employment status (working vs retired), age, and temperament.  Older, retired people may have less ability and time to recover from losses.  Younger people have more time and may be able to tolerate more risk.  If it would bother you greatly to lose money in the short term, then you may want to be more conservative.  In his book, The Intelligent Investor, Benjamin Graham recommends that 25 to 75% of your total investment be in stocks.  The exact amount is up to you to determine.

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