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.
Most investors believe that the cornerstone of an investment portfolio is based upon researching individual stocks and actively trading them. Others believe that getting stock tips, timing the market, or using sector rotation is the key to success. Of course, much of the advertising for brokerage account such as eTrade, or Fidelity, reinforce these misperceptions as active trading is more likely to benefit the broker than the investor.
In reality, investing success is overwhelmingly due to creating the asset allocation that matches your risk tolerance, and trading as little as possible except for an annual rebalancing back to your target allocation. The seminal 1995 Brinson, Hood, and Beebower study showed that 93.6% of portfolio returns were explained by the asset allocation. On average, active management actually detracted from returns by about 1% per year.
Studies have shown that active traders underperform buy-and-hold investors by around 1.5 percentage points per year. When Vanguard examined a group of accounts that had superior performance, they found that those accounts had made no changes versus the majority of accounts that traded frequently.
As the economist Paul Samuelson said: “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”
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.