Money is like soap, the more you handle it the less you will have.on Monday, 17 March 2014. Posted in Investments, Market Flash
To illustrate that an investor’s intuition and actions often prove counter-productive, famed economist and Nobel Laureate Eugene Fama once said, “Money is like soap, the more you handle it the less you will have.”
Legendary investors from Warren Buffett and Peter Lynch to Mario Gabelli have all made the same point. Numerous academic studies clearly show a significant gap between the return achieved by an investment, say a mutual fund or exchange-traded fund, compared to the return achieved by an investor. The root of the problem? Simply put, our emotions, reactions, and behavior cause underperformance.
So, here we go again. As the crisis in Ukraine continues to develop and markets around the world react to the related geopolitical threats, investors’ emotions will likely run high, and with them the risk of making costly “market timing” mistakes. While all of this may seem obvious, most of us still tend to react or even overreact to media reports of impending doom and market crashes.
So, I thought I’d share a few strategies to help minimize the risk of reacting to media headlines, and hopefully keep your portfolio on track:
- Understand that psychology plays a significant role in the investment decision process. Therefore, learn to keep your emotions in check and don’t allow yourself to be swayed by sensationalized media reports. Act on what you know, not what you feel.
- Embrace underperformance. While no one wants to underperform the market, doing so, especially in a year like 2013, isn’t disastrous. To the contrary, underperforming the Stand & Poor’s 500 Index in a strong bull market as a result of having a diversified portfolio is beneficial.
- If you are a “go-it-alone” investor, follow one or two strategists at most. If you are spending more time reading market research reports than you are with your family, you are overdoing it, and are likely getting conflicting view points as well as contradicting guidance. This confusion can often lead to fear, which is a dangerous emotion to base your investment strategy on (greed is no good either).
- Patience and discipline are the best virtues when it comes to investing. An initial investment of $1,000 in the S&P 500 on Jan. 1, 1970, would now be worth $77,810 –— which equates to a compounded rate of return just over 10%, according to Bloomberg. If you missed the 25 best and worst 25 performance days (50 out of nearly 11,000 trading days) in the 43-year period, your annualized return would drop to just under 8% — costing you about $10,000.
As an investment advisor I firmly believe that working with a professional provides investors with the best chance to reach their financial goals and avoid costly emotional mistakes. None-the-less, I recognize that many investors chose to go-it-alone – for those of you who fall into that category, recognize that when it comes to portfolio performance, we are often our own worst enemy.
Source: Amit Chopra, Market Watch