The Importance of Good Investor Behavior
When asked to summarize our investment philosophy, we can distill it down to seven words: Minimize costs, maximize diversification, and control behavior. In today’s blog, we will focus on the final point.
The mentor of Warren Buffett, Benjamin Graham, wisely observed, “The investor’s chief problem—even his worst enemy—is likely to be himself.” Indeed, the potential damage resulting from ill-advised behavior far exceeds the burdensome cost of paying an unnecessary 1% or even 2% annual fee to a financial advisor. To understand this, consider the poor investors who sold out in late March 2020 when the market was down 34% only to miss a 68% gain through the end of the year (based on the S&P 500 Index). This behavior is motivated by the fear of a painful loss (beyond what they have already endured) in their investment accounts, which in many cases is much more intensely felt than the pleasure of an equivalent gain.
The news of the day is often alarming (especially during these difficult times) and can easily motivate an investment decision that by all appearances is completely logical and rational. Before pulling the trigger, however, an investor should ask exactly what he or she knows that the millions of other market participants do not? The answer is nothing, meaning that the current prices already reflect all the news that is flashing across his smartphone screen. Furthermore, if the news truly is bad, then those prices are appropriately discounted, implying a higher future expected return.
The essential problem with trying to time the market is that you must be right not just on the sell date but also the date that you buy back in. The great John Bogle once remarked that not only had he never met anyone who was successful at market-timing, he had never met anyone who met anyone who was successful at it. Successful investors establish a risk-appropriate, well-diversified portfolio and stick with it, rebalancing as needed, regardless of what is happening in the market.
Another highly destructive behavior often seen among investors is performance-chasing, the tendency to allocate towards fund managers, asset classes, and individual stocks that have exhibited recent high performance (e.g., Tesla). The motivator behind this is the fear of missing out, especially when listening to friends and colleagues boasting about their newfound riches. Beginning in 2000, we saw all too clearly the damage resulting from performance chasing of dot-com stocks.
These and other destructive behaviors derive primarily from overconfidence. Just as 90% of us rate ourselves as above-average drivers, we find it near impossible to accept that compared to all the other participants in the financial markets (just remember, for every buyer there is a seller), we possess no special knowledge that entitles us to above-average returns. However, exhibiting the character traits of patience, discipline, and perseverance will deliver more than adequate results for long-term investors. One of our favorite Warren Buffett quotes goes as follows: “You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with a 130 IQ.”