The fastest way to investment failure is listening to the siren song of the financial markets to “do something.” Here are four strategies to help you tune out the noise and stick to your plan.
Interest rates might rise. ISIS may strike again. US stocks are overvalued. The US dollar is too strong. Economic growth is too slow…this constant barrage of news is designed to make you act – to do something – to regain a lost sense of control over the events around you. It is a normal human tendency to act. We want to do something because acting gives us the sense we can affect an outcome. It goes back to the ancient fight or flight response. We run from a fire or fight off an attacker. We. Must. Survive.
The problem is these strategies work neither in our financial lives, nor in financial markets generally. Add to that the tendency to view complex systems as requiring professional help. You can regain control, but not in the ways you might think. Here are four strategies that work when employed:
1. Investing correctly requires internal action (as in self-control), but infrequent external action. Write out an Investment Policy Statement (IPS) that has your portfolio allocation, and then actually sign it, to enforce your commitment to follow it. Strictly. Set your allocation, and only re-balance occasionally.
2. Accept that investing does not have to be exciting. Boring is a good thing. If you find it exciting, then chances are you have too much allocated to stocks. If you are having any trouble sleeping over your investments, or you have to check the markets throughout the day, you probably have too much in stocks. Revisit your allocation of stocks versus bonds. Take an honest assessment of your need, ability, and willingness to take on risk, then set your allocation accordingly. The allocation should be at a risk level that makes you almost indifferent to what happens in the stock market.
3. Accept you cannot look away, but leave it at that. I know the financial markets are like a car wreck, and you cannot look away. You have to see what is happening. If you can tune it out entirely, congratulations. Otherwise, accept that curiosity is natural. Just make sure to move on to something else after checking.
4. Revisit the concepts of opportunity cost and efficient market theory if you still feel the need to act. These are two concepts folks tend to struggle over. Opportunity cost here means that time in the market is more critical to investment success than trying to time the markets. A common example of this is to consider that just a few very large single day moves, if missed, can substantially alter your investment results. There is no way to know just when they will occur. By setting an allocation and sticking to it, you are always in the market. If the allocation gets out of balance, then you can periodically re-balance (once every year or two is fine). You also have to have some exposure to risk if you expect your savings to keep up with inflation. Efficient market theory means that individually, even highly skilled investors can rarely find prices that do not already reflect all known information in the markets. Even those who can somehow manage to outperform the collective wisdom of markets can rarely continue to do so, especially after accounting for the taxes and expenses of the higher frequency trading involved with active management. Over the long haul, passive indexing is the best approach to investing.
Apply these four strategies and you can regain a feeling of control in your investment life. You do not need an adviser, broker, or investment “professional” if you do just these four things yourself.