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Here's the Most Important Factor in Successful Investing

By Matthew Frankel, CFP® – May 8, 2020 at 6:37AM

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This is the most important determinant of your success as an investor, and it might not be what you think.

What makes a successful investor? Is it knowing how to properly and thoroughly analyze stocks? Is it knowing the right times to buy and sell? Or is it simply investing as much of your extra income as you can?

Admittedly, it's difficult to name just one factor that is most important to successful investing. And in order to be a very successful investor, a combination of factors need to be present. Let's look at a few.

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Image source: Getty Images.

Knowledge. Knowing how to invest is obviously an important determinant of investor success. New investors (and experienced ones) should strive to learn as much as they can about how the stock market works, how to analyze potential investments, and good reasons to buy and sell stocks. One of the best uses of your spare time as an investor is to read some of the best books on investing. Warren Buffett, Peter Lynch, and Benjamin Graham have an immense amount of knowledge they've shared with investors, so take advantage of it.

Long-term focus. The stock market can take investors on quite a roller-coaster ride. In fact, moves of 20% or more in a single year aren't too unusual. However, over the long run, the stock market is a remarkably reliable place to create wealth. Depending on the exact time period you're considering, the S&P 500 has generated annualized total returns of roughly 10% over long periods, which can produce returns of more than 1,500% over a 30-year time horizon. Investors who jump in and out of stock positions hoping to capture big price movements and move on rarely beat the market over the long run. Maintaining a long-term focus is certainly one of the most important characteristics that a successful investor needs.

Saving money. Of course, all of the investment knowledge and long-term focus won't do any good if you aren't setting any money aside to invest. Successful investors steadily allocate money to their brokerage accounts or their retirement investments, and also tend to prioritize their emergency savings. After all, it can quickly derail your investment strategy if you need to withdraw from your brokerage account for every unforeseen expense.

The most important factor of all

It might seem like those three things would be enough. But they're not. The effectiveness of these three factors is all dependent on the most important one of all: your temperament.

Humans are emotional beings. We are genetically predisposed to making knee-jerk decisions, following the crowd, and generally acting irrationally, especially when it comes to our finances.

What is the right temperament for an investor? As Warren Buffett puts it, "You need a temperament that neither derives great pleasure from being with the crowd or against the crowd." In other words, you need to be able to trust your knowledge, apply logic and analysis to your investment decisions, and avoid a herd mentality.

It is our instinct to be greedy and put our money into the market when prices are rocketing higher (known as "fear of missing out") because everyone else is making money, and naturally, we want in on the action. Then, when our stocks are plunging, fear takes over, and we start wondering if we should sell "before things get much worse."

Can you imagine if you decided to sell at the depths of the financial crisis and stay on the sidelines for a year? You would have missed out on nearly 70% of gains. Or if you had decided to throw your life savings into a Nasdaq index fund at the height of the dot-com bubble in 1999? It would have taken you nearly 20 years just to get back to even.

On the other hand, if you had decided to steadily put your money to work in high-quality stocks or index funds over time without regard for what the crowd was doing or what news commentators were saying, you would have done just fine long term, despite the crashes and market panics along the way.

How to work on your temperament as an investor

Unfortunately, temperament is often the most difficult part of investing to get good at. A fair amount of it comes with accumulating knowledge -- for example, if you know that crashes are a normal part of the stock market, it can help prevent panic selling. If you know some basics of stock analysis, you can avoid buying an overhyped company just because it's popular.

There are some other smart things you can do. Learn from your own mistakes (all investors make some) and from the mistakes of others, and always make sure you have a good answer as to why you're thinking of buying or selling a stock before you make any transaction.

Learning to essentially ignore your emotions can be a difficult skill to master, but it's a major determinant of your success as an investor, so it's important to make it a priority.

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