5-Steps to Disciplined—and More Profitable—Investing

05/01/2013 9:00 am EST


Robin Carpenter of Cabot Wealth Advisory shares his five steps to becoming a disciplined investor.

Investing discipline means adherence to a plan—a specific plan. Here are five fundamentals that should be part of any disciplined investment program.

Make Your Strategies Specific. I recommend having several strategies, as no one strategy works well all the time, or forever. Investment strategies come in many flavors: Stock-picking, market timing, indexing, mutual fund, commodity, and options strategies. With the explosive growth of ETFs, there are now hundreds of new vehicles to implement an immense range of strategies.

Whatever your strategy, you should be specific. If you’re trading on trends, define what will constitute a trend, and how you will decide when it’s over. If you’re investing in new technologies, define what kinds of technologies are eligible, the expected time frame for realization, and potential size of the businesses. If you’re writing calls, be specific about how to identify candidates, and how to set price, strike and duration combinations.

In our ETF Investing System, our strategy is to rotate among sector ETFs, with an overlay of trend-based market timing. Sector selection comes from an econometric model that ranks the nine major S&P ETF sectors every month. The model is specific, so we always know which sectors are favored and which are not. The system also defines market uptrends and downtrends using a mathematically specific timing model. On any given day, we know which sectors to hold, and which direction is in play.

Not every strategy can be as mathematically specific as our system. But even a strategy based on personal judgment can specify the factors to be considered. And any strategy can (and should) define what vehicle will be traded, procedures to follow, and expected returns.

Write It Down. This serves several purposes. First, it’s a check to make sure the “specifics” are really specific. What if this, what if that? Writing also helps burn it into our minds, so that (ironically) having it on paper helps make it less necessary to refer to the paper over time.

Putting your rules in writing also helps prevent strategy drift. It’s all too easy to start taking positions or actions inconsistent with the strategy, telling ourselves that a bit of deviation is okay “just this time.” Lastly, having your strategy recorded will help you when it’s time to change plans. You’ll have a basis to know you’re being consistent and deliberate.

Make Periodic Reports. Choose a relevant reporting cycle and convenient format, and track your progress regularly. You’d insist on regular reporting if you had someone else running your strategy; don’t accept anything less from yourself.

Seek an Audit. None of us is quite as objective (or critical) about ourselves as we are with others. It can really pay off to have some other eyes review the progress and effectiveness of the strategy.

This audit needn’t be an exhaustive or expensive analysis. The primary issues are:

(a) Is the strategy being faithfully followed?
(b) Is the strategy as productive as expected or planned?
(c) Are there aspects of the strategy that deserve revision or recalibration?

That last issue is the step that will keep your program current and productive.

Revise. When there are changes to be made, don’t make them on the fly. You have your strategy written down to help keep you on course, and if the course is worth changing, your strategy statement deserves an update. Revision is the final stage of discipline—to not simply follow the plan but constantly try to adapt and improve the system as time goes on.

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