ABCs of Behavioral Biases (A to F)
Four self-inflicted biases that knock a number of investors off-course are anchoring, blind spot, confirmation and familiarity bias.
In our last piece, “Managing the Market’s Risky Business,” we described how diversification plays a key role in minimizing unnecessary risks and helping you better manage those that remain. To round out the conversation, we will cover another benefit to be gained from a well-diversified stable of investments: It helps create a smoother ride toward your goals.
Like a bucking bronco, near-term market returns are characterized more by periods of wild volatility than by a steady-as-she-goes trot. Diversification helps you tame that beast. Because, as any rider knows, it does not matter how high you can jump if you fall out of the saddle.
When we crunch the evidence-based numbers, we discover that diversification helps minimize the bucking you must endure along the way to long-term expected returns. Imagine several rough-and-tumble, upwardly mobile lines that represent several kinds of holdings. Individually, each represents a wild ride. Bundled together, the upward mobility remains, but the jaggedness along the way can be smoothed (albeit never completely eliminated).
Fidelity’s “Guide to Diversification” describes how diversification and individualized portfolio construction can help you tame the market’s best and worst investment outcomes according to your goals. For a more detailed, data-driven illustration of the same, check out “How to Diversify Your Investments” by financial author Larry Swedroe.
A key reason diversification works is related to how different market components respond to price-changing events. When one type of investment may zig due to particular news, another may zag. Instead of trying to move in and out of favored components, the goal is to remain diversified across a variety of them. This increases the odds that, when some of your holdings are underperforming, others will outperform, or at least hold their own.
The result of diversification is not perfectly predictable, but it offers a blanket of coverage for capturing random market returns where and when they occur. This goes a long way toward replacing nerve-wracking guesswork with a more coherent investment strategy.
Diversification offers you wide, more manageable exposure to the market’s long-term expected returns, as well as a smoother expected ride along the way. Perhaps most important, it eliminates the need to try to forecast future market movements, thus reducing those disruptive self-doubts that throw so many investors off course.
So far, we have introduced some of the challenges investors face in efficient markets and how to overcome them with a well-diversified portfolio. Next, we will pop open the hood and take a closer look at how to tune up your own investment portfolio’s performance.
FREE FINANCIAL ASSESSMENT
With all the uncertainty and volatility in today’s economy, the time is now to take a thorough look at your finances. To accurately plan for your financial future, you must first know where you currently stand. For these reasons, our Success Team at Impact Advisors Group is offering a free financial assessment for both individuals and business owners. Request yours today!
This post was written and first distributed by Wendy J. Cook.
Four self-inflicted biases that knock a number of investors off-course are anchoring, blind spot, confirmation and familiarity bias.
Legendary economist Benjamin Graham once stated that ‘your own behavioral biases are often the greatest threat to your financial well-being.’
If you file tax returns separately AND are separated from your partner, colleges consider you a two-household family.
Take some time to map out how to pay for all four years before your student gets the bill for freshman year.