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.
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.
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This post was written and first distributed by Wendy J. Cook.
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RISKS
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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.