• Michael Weiss

The 7 Habits of Highly Effective Investors

Updated: Sep 19, 2020

Managing your finances can seem overwhelming. We live in a world where information overload is the norm, and the advice we receive is forced down our throats. Of course, we all want to be financially independent and stay on track to achieve our long term goals, but how are we supposed to digest everything and use it to help us make critical decisions about our personal wealth?

When it comes to money management and investing, I like to take a simplified approach, and it’s widely recommended that most people do the same. Harold Pollack, a professor out of the University of Chicago, is notorious for fitting the basics of good personal finance on a 3x5 index card (original version shown below).

Image Credit: Harold Pollack

The handwriting isn’t the best, but his advice is straightforward and simple enough for anyone to maintain financial well-being. I believe most of it still holds true today and will remain pertinent in the long term (with some caveats that I’ll get in to later). Citing Pollack’s advice, Bloomberg put out a feature titled The 7 Habits of Highly Effective Investors (not to be mistaken with Stephen Covey’s 7 Habits of Highly Effective People, which you can find on my reading list).

I summarize the main ideas of the Bloomberg article below, and add my personal insights to each “habit”, including how you can put each of them into practice.

1. Automate your savings, and save early on

It’s no secret that the earlier you begin saving, the quicker you will accumulate wealth. Also, if you set up a system where your money is automatically moved into a separate savings or investment account, you’re much more likely to be disciplined in your approach.

Most online brokerage platforms have an “automatic transfer” feature where it transfers a specified amount from a linked bank account each month, so you don’t even have to think about it. I use this in my own account, and it’s rewarding to see my money grow without much effort.

But how much is enough? Pollack recommends saving 20% of your income. For a lot of people, this is a stretch, but the idea is that you should form the habit of saving as early and as much as you can (or at least as much as it makes sense for you). As your income rises, you should plan to proportionately increase your savings.

Most of you may know about the power of compounding interest. The idea is that your investment gains grow exponentially, so the earlier to you are in the game, the larger the payout in the end.

Image Credit: TD Ameritrade

Assume a perfect world where market volatility doesn’t exist and fees, expenses and taxes are nonexistent. Also, assume you find $24k in your coat pocket as a 21 year old (talk about a good day!) and you don’t blow it all on a Rolex. Ah yes, the classic utopia you learn about in Finance 101. Whatever – follow me here: If you invested that $24k when you were 21, and assuming an 8% annual return, you would have $412k more to your name 46 years later, versus the same scenario beginning at age 47 with an investment horizon of only 20 years. This is solely a hypothetical exercise, but nonetheless it drives home the reason why you should have started saving yesterday.

To help you get started, I recommend using Betterment – an online tool that empowers artificial intelligence to deliver customized money management solutions in order to optimize your spending, saving, and investing activities all on one comprehensive platform. If you sign up using my referral link, you'll get your first $5,000 managed for free.

2. Expect the best, prepare for the worst

What’s life without your car breaking down, your dog getting sick, breaking your arm, or even worse getting fired? I never wish any of the above happen to you, but expect the unexpected – start an emergency fund.

I learned this the hard way. In college, I was hit with an expensive car repair that wiped out a good chunk of my checking account, and I had to liquidate a few of my investments in order to pay my rent that month. Needless to say, we don’t invest for the purpose of covering auto expenses nor paying rent for a college apartment (these are what we call sunk costs). If I had funded a separate emergency fund beforehand, I would not have felt the same burden as I did when I had to sell stocks that were helping me accumulate wealth. I fell within the 41% of Americans who do not have money saved for a rainy day.

Image Credit: Bloomberg

Afterwards, I set a new financial goal to accumulate 6 months of living expenses in a separate liquid account. Each paycheck, I make proportionate contributions until I hit my goal amount. I know, it’s not sexy, but it helps me sleep better at night and will probably do the same for you. This is another great reason to use money management tools (such as Betterment) to automate your savings and stay on track.

As always, be realistic in assessing your current lifestyle. The amount in an emergency fund should align with a “worst-case scenario” given your actual financial obligations.

3. Diversify your asset allocation

The golden rule when it comes to investing is to diversify your portfolio. Trying to time the market or pick the right stocks as your main strategy is fun, but it’s not the best idea (more on this in my post on day trading). Rather, diversifying into a mix of assets according to your risk profile and investment objectives is the best way to get started.

For years, we have been told that a 60/40 portfolio is a good baseline for asset allocation. The idea is that you hold 60% of your portfolio in large cap stocks and 40% in Treasury bonds, and then you tilt the scale in favor of fixed income as you get older. However, with today’s historically low bond yields, and a medium to long-term outlook of low interest rates, I’d say 40% is too heavy for most investors.

You have the 10-yr US Treasury bond hovering around 70 bps (0.70%), while inflation averages about +2% per annum. If bonds (or any security for that matter) cannot outpace inflation, you are effectively losing money by holding them.

Even worse, economists widely expect US inflation to ramp up as stimulus dollars are pumped into Americans’ bank accounts during the coronavirus pandemic. In a period of economic recovery where interest rates remain low and pent-up demand could spur moderate inflation, bonds have a grim outlook compared to equities, which have largely outperformed the former over the past decade+.

That being said, everyone is different, so there is no universal asset allocation mix. Coming from a young investor, holding a globally diversified (mainly US large-cap growth) equity portfolio with a sprinkle of fixed income in the form of investment-grade corporate bond ETFs and high-dividend paying companies has been a successful strategy over the past 7 years. Of course, I make adjustments according to changes in my own life.

4. Avoid high fees

I’ll admit it, I never paid attention to fees when I first started out, but after sitting through an entire 4-hour lecture dedicated to mutual fund compensation structures, I began taking notice in my own portfolio.

In that lecture, I learned that even a mere 3% annual fee can cost you millions. For example, let’s say you invest in a mutual fund because a pushy adviser convinced you to do so (more on this in habit #5). You invest $10k in the fund to start out, and you contribute $1k/month thereafter for 30 years. The fund returns 10% per annum, and it’s annual fee is 3% with no front or back-end sales charges.

After 30 years, in the scenario above, you would end up with $1.3 million. Not bad right? What if you had the same scenario, but the fees were 0%? You would end the 30 years with $2.5 million in your account. That’s right – over the course of 30 years you paid the mutual fund company nearly half ($1.2 million) of your true dollar return. See the spreadsheet below.

This forms the argument based on investing in passively managed funds, such as low-cost index funds prescribed by the likes of Pollack and Warren Buffett, and avoiding actively managed funds with exorbitant fees that are likely to underperform.

Contributions: Dr. Jeffrey Donaldson, The University of Tampa

5. Make sure your adviser is acting in your best interest

Revisiting the scenario from above: the mutual fund company banked $1.2 million off of you! Your adviser might have sold that specific fund for an ulterior motive (such as a commission). I am not against consulting with a financial adviser, especially since the credible ones are held to a fiduciary standard. But it’s important to do your research and know who you are working with, which products they can sell you, and what their fee structure is.

Are there other investments suitable for you with lower fees and a similar risk/return profile? If your adviser is a fiduciary, he’ll give you recommendations acting in your best interest. If not, take your business elsewhere.

6. Keep your lifestyle in check (Earnings > Spending)

This is the most straightforward habit. Do you make more money than you spend? Or do you live paycheck to paycheck? Quite simply, if you live below your means, then you have the opportunity to save and set financial goals for yourself. Otherwise, you are likely trying to keep up with a lifestyle you think will impress people, who in reality could not care less about you.

I don’t mean to be cynical. I think it’s healthy to splurge on things you really enjoy or are passionate about, but only if it truly brings you happiness. If not, you are falling into the trap of keeping up with the joneses, which is an expensive and unfulfilling way to live. Get real with yourself – you will be much happier.

7. Utilize the most of your employee benefits

Again, a simple concept that most people struggle with. Forgoing your employer’s full 401(k) match is like saying no to free money. But this isn’t limited to retirement accounts. Your employer hopefully incentivizes you with attractive benefits to keep you with them longer. Take a moment to understand what is available to you in your benefits package and find out how omitting more from your paycheck can actually advance your finances, including income tax sheltering (your reported wages will be lower, and you will therefore pay less in taxes).

Join the Conversation

I hope you found this article interesting and that it sparked some creativity for new ways to improve your financial well-being. I want to know what you do to stay on track and motivated to save, and how you put your money to work. Have any of these 7 “habits” been helpful (or unhelpful) to you? Would you add or remove anything to the list? Share your thoughts below.

Disclaimer: Nothing on this page constitutes as any sort of financial advice and is meant solely for the purpose of sharing thoughts and ideas. To avoid employer compliance and FINRA violations, I do not, and will not discuss any proprietary information that comes across my desk at work. Every link and piece of information on this page is readily available to the public via the internet.