Don't Let Emotions Drive Your Investment Strategy
Chip Brackley | May 19 2021
With all of the volatility in the market the last few months, I wanted to discuss the impact emotional investing can have on your portfolio. It's important to keep in mind that having the ability to shut out the noise during challenging times is one of the biggest factors in helping individuals may smart investing decisions.
As investors, many of us are hyper focused on returns… especially over the short-term.
What we’ve learned over the years is that this type of focus tends to leave us feeling anxious and nervous and less than satisfied with our returns over the long term.
How short-term investing bias plays out in real life:
From 1977 to 1990, legendary investor Peter Lynch ran the Fidelity Magellan fund and over this period the fund returned an unbelievable 29% per year. With those types of returns, you are essentially doubling your money every 3 years.
But when Fidelity decided to do a study to see how the investors in this fund actually fared; the results were astounding… The average investor actually LOST money in the fund over that time period.
How does that even happen? Let me explain…
The average investor lets emotion drive their decisions. The market is up, they feel good so they buy. The market is down, they feel bad so they sell. Exactly the opposite of what we should be doing.
To back up the Fidelity study, research by JP Morgan shows that returns for the average investor are barely in-line with inflation, meaning that over the last 20 years the average investor has returned a little over 2% per year, while the S&P returned a little over 7%. That is a huge gap.
So, research has proven that the average investor can have their cake……the returns are there, but emotional decisions are preventing them from eating it!!
So how do we not let this happen? How do you try and get solid returns and not make emotional investing decisions?
The first thing you need to get right is your allocation. You should strive to build an “all weather” portfolio which is a diversified portfolio that works well in various types of environments. This portfolio should be based off several things, but let me mention three that we think are ultra-important…
- Your risk tolerance… how much can you stomach your account going up and down?
- Your goals… what are you trying to achieve and do your investments line up with those goals?
- You need to take into account all of your assets. Don’t just think about your stocks and bonds. Do you have shares of company stock, ownership in a small business or maybe private equity investments that are all less flexible but have considerable impact on your overall net worth?
Those are three things you really need to key in on. Your risk tolerance, your goals and your overall assets. In regard to risk, the first one, this is what we have found over time.
Most people can’t stomach the swings in the market as much as they think they can. They think they want to be aggressive, but when the market rolls over they really don’t want all of that downside.
In reality, over the last 50 years, the S&P has returned 11% while a balanced portfolio returned 9%. That’s not a huge give-up for a lot less risk.
Here’s the bottom line, here’s what you need to do…
Most important… have a financial plan. Then, build a simple, low cost and diversified mix of investments that lines up with your risk tolerance and your goals. The simpler your plan and the simpler your investment process, the better off you are. Doing this will bring confidence in and move emotions out. Don’t make decisions based on your feelings about the market. That’s how to be a smart investor.
Ready to see how you stack up? Get started today, by better understanding your risk tolerance level and how that fits with the investments you currently hold.
Disclaimer: Our intent in providing this material is purely for informational purposes, as of the date hereof, and may be subject to change without notice. This article does not intend to constitute accounting, legal, tax, or other professional advice. Visitors and readers should not act upon the content or information found here without first seeking appropriate advice from a trusted accountant, financial planner, lawyer or other professional.