As a parent, I often remind my children to behave when I leave them with friends or relatives, and most of the time they do. However, many children, including my own, pass through extended periods during which they transform from cute, lovable beings into gremlins (often in the presence of parents) that spread toys, food, and clothes all over the house, leaving a wake of mental stress and making parents question their sanity. It is during these moments that parents continually provide feedback and coach their children on proper etiquette, thereby developing citizenship. Without this oversight, bad events can happen, like the teenage parties we have seen in movies – or, worse yet, someone becoming injured.
As a financial planner who has been through two major market swings, I have met parents who did not have proper oversight of their financial lives, resulting in the same destructive consequences of a teenage party. One large difference does exist: The parents who move quickly to correct a minor’s behavior often do not have someone holding them accountable for bad financial behavior. In fact, most do not even realize that a bad habit exists. Here are a few of the most common investing behaviors to correct.
Jay Mooreland points out in his article “The Cost of Ignoring Behavioral Biases,” that overconfidence is the belief that we always make correct decisions in our best interest. Often, a case of overconfidence surfaces during the NCAA college basketball tournament when a fifteen seed upsets a second seed. It is part of what makes March exciting, but it leaves the normally disciplined basketball team wondering what happened.
Past performance is not a guarantee of future returns. Investors see this and understand its meaning, yet they look at what has performed the best over the previous year or quarter and put investment dollars in the hot arena. This is a form of anchoring; we look to the past to predict the future with anecdotal data to help us “justify decisions.” Need proof? Watch retail investor dollars over an extended time. Money flows into areas that have done well and out of underperforming areas.
ATTRACTION TO RISING PRICES
Think about the last time gas prices rose. We saw a decline in travel, and we started carpooling or riding our bikes to work. What happens when an item goes on sale? People wait to see a price decline in desired items before completing a purchase.
Yet in the stock market, the opposite normally happens. People rush to buy at times when the market has done well out of fear of missing out or out of greed for money. Warren Buffet has a famous quote: “Be fearful when others are greedy and greedy when others are fearful.”
FEAR OF REGRET
Fear and greed are powerful emotions. Fear, the stronger emotion, can paralyze a person, preventing him or her from taking action or causing him or her to run away. We do not like being wrong, as regret makes us lose confidence. Instead of facing the effects of a bad decision, no decision is made.
I still encounter people who moved to cash after the 2008 crisis and who will not reinvest even if their circumstances require it. I ask why, only to hear, “What if the market goes down again?”
FRAME OF REFERENCE
In my post, Risk Characteristics, the importance of perceived risk was discussed. If the perceived risk does not match the real risk, normal behavior may not be pursued. For example, over the past five years, many US investors have overweight US stocks. Why? Because performance is compared to the S&P 500. There are two main effects: 1. Risk increases by reducing diversification, and 2. Buying at or near a top happens. The cure is simple. Keep a globally diversified portfolio and rebalance to lower risk and to buy asset classes while they are down.
How many of these behaviors do you exhibit? Who is holding you accountable for achieving your vision? If you do not have answers to either of these questions, perhaps it is time to consider discussing your details with a professional. If you do have the answers, are you learning from the mistakes? A good planner will be there to coach you toward the correct behaviors while not passing judgment or making you feel like a failure.
Here are two parting quotes:
“The risk is in the behavior of the investors.” Howard Marks
“That truth is that human behavior is a better predictor of whether or not we’ll reach our financial goals than anything else.” Dr. Daniel Crosby