![Conclusion: The ABCs of Behavioral Biases](https://impactadvisorsgroup.com/wp-content/uploads/2024/08/Conclusion-The-ABCs-of-Behavioral-Biases-300x200.jpg.webp)
Conclusion: The ABCs of Behavioral Biases
During this series, we have learned that our own behavioral biases are often the greatest threat to our financial well-being.
As an investor, second-guessing a stable strategy can leave you in the weeds. Trading in reaction to excitement or fear tricks you into buying high (chasing popular trends) and selling low (fleeing misfortunes), while potentially incurring unnecessary taxes and transaction costs along the way.
Still, what do you do if it feels as if your investments have been underperforming? It helps to lead with this key question, to decide if the impression is real or perceived:
How am I doing so far… compared to what?
It is easy to be dazzled by popular stocks or sectors that have been earning magnitudes more than you have, and wonder whether you should get in on the action.
You might get lucky and buy in ahead of the peaks, ride the surges while they last and manage to jump out before the fads fade. Unfortunately, even experts cannot foresee the countless coincidences that can squash a high-flying holding, or send a different one soaring. To succeed at this gambit, you must correctly, and repeatedly decide when to get in and when to get out in markets where unpredictable hot hands can run anywhere from days to years.
Also remember that if you simply invest some of your money in the global stock market and sit tight, you will probably already own today’s hot holdings. You will also automatically hold some of the next big winners, before they surge (effectively buying low).
Rather than comparing your investments to the latest sprinters, be the tortoise, not the hare. Get in, stay in and focus on your own finish line. It is the only one that matters.
What if your investments seem to be underperforming, not just the high-flyers but the entire market? Maybe you are seeing reports of “the market” returning several percentage points more than you have lately. What gives?
Remember, when a reporter, analyst or others discuss market performance, they are usually citing returns from the S&P 500 Index, the DJIA or a similar proxy. These popular benchmarks often represent one asset class: U.S. large-cap stocks. As such, it is highly unlikely your own portfolio will always be performing anything like this single source of expected returns.
Most investors instead prefer to balance their potential risks and rewards. For example, if your portfolio is a 50/50 mix of stocks and bonds, you should expect it to underperform an all-stock portfolio over time. But it also should deliver more dependable (if still not guaranteed) returns in the end, along with a relatively smoother ride along the way.
Even if you are more heavily invested in stocks than bonds, a well-diversified stock portfolio will typically include multiple sources of risks and returns, such as U.S., international and emerging market stocks; small and large-cap stocks; value and growth stocks; and other underrepresented sources of expected return.
Thus, we advise against comparing your portfolio’s performance to “the market.” Usually, any variance simply means your well-structured, globally diversified portfolio is working as planned.
At last, we reach a comparison that makes more sense. Your portfolio should be structured to reflect your financial goals and your ability to tolerate the risks involved in pursuing your desired level of long-term growth. Thus, a more appropriate comparison is made among the “building block” investments available to achieve this ideal.
Once you have built a portfolio that reflects your goals and risk tolerances, there are really only two reasons your particular selections might underperform similar investments.
1. Poor Fund Management: Are your products or solutions accurately capturing the specific sources of return they are meant to deliver?
2. Excessive Costs: Are there lower-cost choices for achieving the same aim?
If your investments are accurately capturing the sources of return you are seeking, you are not spending too much to make this happen, and you or your portfolio manager do not have to make constant adjustments just to stay on course. Any other comparisons become largely irrelevant for your investment journey.
Admittedly, it can be easier said than done to avoid inappropriate performance comparisons and identify appropriate solutions as described, across shifting times and unfolding events.
We are here to help with that. In roaring bull and scary bear markets alike, we team up with our clients to address these critical “Compared to what?” questions about their investments. It is what we do to ensure they can accurately assess where they stand, and where they would like to go. Please do not hesitate to contact us if you are interested in opening up a conversation with our team.
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.
DISCLOSURES
The information in this material is intended for the recipient’s background information and use only. It is provided in good faith and without any warranty or representation as to accuracy or completeness. Information and opinions presented in this material have been obtained or derived from sources believed by Dimensional to be reliable, and Dimensional has reasonable grounds to believe that all factual information herein is true as at the date of this material. It does not constitute investment advice, a recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. Before acting on any information in this document, you should consider whether it is appropriate for your particular circumstances and, if appropriate, seek professional advice. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized reproduction or transmission of this material is strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.
This material is not directed at any person in any jurisdiction where the availability of this material is prohibited or would subject Dimensional or its products or services to any registration, licensing, or other such legal requirements within the jurisdiction.
RISKS
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.
During this series, we have learned that our own behavioral biases are often the greatest threat to our financial well-being.
It is worth revisiting some of the basics about the stock market, and debunk some common myths.
In the final alphabetical installment of our Behavorial Biases Series, let’s dive into sunk cost fallacy and tracking error regret.
A four-year college degree is expensive. While the numbers vary, the data on the topic is sobering.