How to stop sabotaging your own investments, part II
In my previous blog entry, How to stop sabotaging your own investments I explored how our investing behavior can be a detriment to achieving our goals and how a sound plan can help to keep investors on track. I would like to continue the discussion by further exploring habits that may have a negative effect on investment performance and can pressure investors to deter from their plan.
Recency Bias
One of the most prevalent behaviors that I see investors exhibit is giving in to the temptation to focus on the returns that a particular investment posts in the very near term. This causes investors to choose a focused portfolio of just a few investments, selling off possibly good investments that are experiencing a short-term period of under-performance and purchasing investments that may be excessively risky or poor quality that are experiencing a short-term period of higher returns.
This action of chasing investments is a strategy that will reap little, if any, benefit over the long term. The strategy’s flaw lies in the fact that very few funds remain in the top percentile of performance consistently over time. Chasing returns in the short term results in selling shares of certain funds at a relatively low price and purchasing others that have run up in price. In simple terms, this behavior means buying high and selling low – the exact opposite of what we strive to do as investors. This is similar to the effect that results from the herd behavior I discussed in my previous posting.
Agency Capacity
Another pitfall that investors face is becoming attached to their investments. If an investor becomes attached to the investments that they choose, then performance is viewed as a reflection on the investor personally. Investments, in this case, are viewed in the same way that a person may view their other possessions such as their home or car. An ‘it may not be the best, but it’s mine‘ mentality sets in, and the investor suffers through long periods of under-performance. In this case an investor will hold poor performing funds longer than they should to avoid admitting that they made a bad decision.
An alternative view is for the investor to see themselves as an executive managing their portfolio as if it were a business, with the investments being their employees. In this role the investor can manage their investments much more objectively. Monitoring performance overtime and replacing investments that consistently under-perform in much the same way that an employer would replace an employee that consistently performs under expectations.
Planning prevents problems
The temptation to fall in to these behavioral traps can be mitigated by establishing and following a sound plan. A plan based on sensible investing principals and updated regularly provides a guide, keeping investors on track to realizing their goals. Not sure how to go about establishing a plan? Revisit my colleague’s article about planning or contact our adviser team at 877.627.8401.
Charlie Koch, Investment Adviser
About Smart401k
Smart401k is a Web-based investment adviser providing unbiased advice to help employees invest in their employer-sponsored retirement plans. Smart401k provides service to almost 11,000 clients who collectively have more than $1.5 billion in assets. Individuals receive personalized investment recommendations based on the funds in their plan and support of professional investment advisers available to answer all investment questions. Based in Overland Park, KS, Smart401k can be found at Smart401k.com.
