The investment plan of every investor should answer the following five questions:
Also, the answers to questions #2, #3, #4, and #5 should be different depending on how a person's stock portfolio is made up. If the answers to questions 2, 3, 4, and 5 are all the same, then all the stocks in the portfolio will have the same risk profile, which is not a good thing.
There is a very good reason why people who try to copy the portfolios of wealthy, successful investors rarely do as well as the investors they try to copy. The reason is that they can only answer one part of the above five-part investment puzzle: the question of what to buy. In fact, I could open my portfolio to 1,000 people who have never invested before and show them all the stocks I own now. None of them would be able to match my future returns. In fact, it is very likely that investors would lose a lot of money on the same stocks that would make me the most money.
Why?
Again, a portfolio's returns will depend on how well the investor understands an entire investment system, not just what to buy.
Why most investment firms' plans don't answer the 5 questions in a good way
The fact that investment professionals' job titles have changed from "broker" to "financial consultant" to "financial advisor" is ironic, since the original title is by far the most accurate for most people who work in this field. Most financial consultants are just brokers who use the money you give them to make more money. They are the middlemen between you and the money managers hired by the firm. They are so similar to each other that the returns on a retail investor's portfolio are not likely to change much from one consultant at the same firm to another.
When I worked as a "broker" at a Wall Street firm, I heard a story about a very successful (meaning he made a lot of money) financial consultant who bought nothing but exchange-traded funds (ETFs) for his clients. He did this for four different reasons.
Global investment companies don't teach their brokers how to pick the best stocks. They teach them how to be the best salespeople possible. So, this consultant's reasoning was wrong when he told his clients that putting all of their money in ETFs was the best thing they could do. The consultant came to this conclusion based only on his investment knowledge, which was mostly about how to sell investments. Even though I could never confirm it, I heard from many different sources that this particular financial consultant was able to do better than the vast majority of other financial consultants at the firm with his "I will only buy ETFs" strategy.
Even though I wouldn't be surprised if this were true, the fact that this consultant was able to get so many clients with such a bad plan says a lot about how little the average investor knows about how to build wealth. I think this shows that the average retail investor, even those with millions of dollars to invest, is much less knowledgeable about how to build wealth than financial consultants are. This is because all they do is sell investment products.
In the end, every individual investor should use the 5 questions of building wealth to figure out if his or her investment strategy is good or bad. All 5 questions will be important for a good investment plan. If you have a bad investment plan, it's likely that one or more of the five questions won't matter. And the strategy's flaws will be clear because the returns will be low. Let's look at a couple of examples to show how the 5 questions of building wealth will "out" any bad investment plan. First, let's look at two different portfolios. One is mostly made up of ETFs, and the other is mostly made up of Mutual Funds.
Neither the Mutual Fund strategy nor the ETF strategy can answer this question, so you don't even need to ask the last four questions to know that neither of these strategies will help you build wealth.
How about a portfolio made up of all different Chinese stocks? This portfolio passes question #1, which is whether or not it has the right stocks. Next, if we look more closely at how this portfolio was put together, the answers to questions #2 and #3 - "When were these stocks bought and why?" and "How were these stocks bought and why?" - by the portfolio manager will show whether or not the portfolio was put together well.
Lastly, the portfolio manager's answers to questions 4 and 5, "How will these stocks be sold and why?" and "When will these stocks be sold and why?" will show if plans are in place to lock in profits or limit potential losses. But don't forget what I said earlier in this article: "The answers to questions 2, 3, 4, and 5 should depend on the different parts of a person's stock portfolio." Most likely, the answers to questions #2, #3, #4, and #5 won't vary much for a portfolio made up of stocks that trade in a hot, new market. This lack of change would show again how weak this investment strategy is.
The 5 questions are just a rough guide, but they should give you a quick way to figure out how smart and strong your current investment strategy is.
