No. 3. Asset allocation: What is the optimal ratio of stocks, bonds, real estate investment trusts, alternates and cash in a portfolio? Academic studies have proven (see this, this and this) that allocation is much more important to returns than stock selection. You can imagine all sorts of scenarios where allocation trumps selection. The greatest stock-picker in the world with a 20 percent equity exposure won’t move the needle very much.
No. 4. Valuation and year of birth: Valuations will fluctuate over the life cycle of any bull or bear market. However, for the long-term investor, valuations are less about expected returns of pricey stocks, and more about when they a) start investing and b) start to withdraw in retirement.
Much of this is a random and beyond your control. Imagine the market crashing just before your prime saving and investing years; that should have a positive impact on net returns over time. What about someone who retired in 2000, and began withdrawing capital after the market got shellacked? That will also have an impact.
Those people born in 1948 not only managed to have their peak earning and investing years (35-65) coincide with multiple bull markets and interest rates dropping from more than 15 percent to less than 1 percent. They also lucked into a market that tripled in the decade before retirement.
No. 5. Longevity and starting early: Having a long investing horizon is determined by many factors, including your longevity. How long you live is going to be a function of genetics, lifestyle and dumb luck.
But when you begin saving for retirement is not a function of genetics or health. The sooner you begin, the longer compounding can work its magic.
No. 6. Humility and learning: We all begin as novice investors. Everyone makes mistakes -- even the greats like Warren Buffet and Jack Bogle. The key question is how quickly you can figure out all of the things you are doing wrong. Self-awareness and ego is a significant thread in this context. The sooner we learn to learn from our mistakes, the better our investment portfolios.
No. 7. Behavior and discipline: Nothing has a bigger impact than the behavior of investors under duress. I stumbled upon this observation early in my career as a trader; everything I have learned since has served to confirm it.
We see this again and again in the data -- just look at DALBAR’s Quantitative Analysis of Investor Behavior. Investors continue to be their own worst enemies when it comes to investment performance. On average, their actions lower their returns significantly, but in the worst cases they demolish them. Even worse, behavior is (or at least should be) within their own control.
Bonus: Luck and random chance: There is a lot of random chance in investing. We often cannot tell the difference between skill and luck in stock selection. And the moment when each realize this can also be somewhat random.