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  • Doug Oosterhart, CFP®

Here's What NOT to Do When Making Investment Choices for 2019

Have you ever looked at the one-year performance for the investment options in your 401(k) and made investment decisions based on them? If so, you are not alone. Whenever I ask why people chose the investments they currently hold (in their 401(k) or other accounts), a lot of times they say it's because they looked at the recent returns and chose the funds with the highest one, three, or five year gain. I then proceed to ask how often they change their investments based on the recent returns. The answers generally differ, but they're usually more than once per year. It's hard to blame people when the first thing they see when clicking on "Investment Research" is the following picture (minus the fund names being blacked out):

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Investors at all levels see gains and inherently think it's a good time to buy that particular fund. Alternatively, when investors see that certain funds have performed worse than others, they think they should make a change. It doesn't matter if someone has $50,000 or $5,000,000, this is simply how the brain works. It doesn't matter if the investor knows they should buy-low and sell-high, ALL INVESTORS MAKE MISTAKES. It's how the human brain is wired. I've never met anyone that buys an investment in hopes that it goes down. However, sometimes investments do go down - temporarily. Warren Buffett's estimated losses during the fourth quarter of 2018 were $37 billion total. Like I said, all investors at all "skill" levels have portfolios that do always go up.

Investors tend to buy-high and sell-low, thanks to how they're wired.

Think about it - if you buy funds that have gone up recently and sell funds that have gone down recently, you're doing the reverse of what it takes to achieve consistent high returns. This is a component of why the average investor consistently under-performs their investments over time. The phrase "average investor" is always interesting when I use it sitting across from clients and prospective clients. No one thinks or wants to think that they are average. However, I can assure you that investors with all sizes of portfolios still fall victim to long-term under-performance. My smartest clients have said that they have made mistakes throughout their investing careers - I'm there to tell them that they are not alone. "The spread between investment returns and investor returns is known as the behavior gap, and it is a permanent feature in any markets where human beings transact. It exists because the collective behavior of millions can overwhelm our senses." - Michael Batnick, Big Mistakes: The Best Investors and Their Worst Investments

Because the human brain functions the way it does, I'm constantly talking to clients about their investment behavior. Frankly, it's not sexy. Clients would much rather hear about what's the newest and greatest investment to buy, or what asset class will be the top performer of the year (by the way, good luck picking the winner - asset class returns). Even though some people think that one works with a financial advisor to get investment picks, it couldn't be further from the truth. In fact, I lost a prospective client in 2018 because I didn't have an answer for, "What stock will make me the most money in the next year?" I don't even think about answers to that question. I think about how I can manage my clients' investment behavior in a way that provides the highest chance of long-term success for their plan with goal-focused investing. I'm flat out not attempting to get the maximum possible returns (whatever that means) - I'm trying to help clients achieve competitive long-term returns which will fulfill their goals with the minimum expenditure of time, energy, and stress. The only rational long-term investment policy is one designed to meet the lifetime and multi-generational financial goals of the household/family. The problem is, it's hard to quantify the value to clients without sounding fluffy. Coaching clients on investment behavior seems meaningless until they call you to move to 100% cash. Better yet, when the "let's give this a try for 6-months" client calls to complain that their portfolio went down in the fourth quarter of 2018. To put it bluntly, I don't even take clients on that have that attitude toward investing. People that think like that will consistently under-perform forever.

So what should investors do when rebalancing or allocating their portfolios for 2019 and beyond?

Since you cannot change how the human brain is wired, it's important to realize and be aware of investment biases and investment behavior thoughts. When you're thinking, "Should I make a change before this gets any worse?", generally investors' brains tell them that either going to all cash, or selling at a loss is a good idea - both of which are what NOT to do, especially when you have a diversified portfolio. Instead, rebalancing the portfolio to actually buy what is down is the correct way to do it (assuming your long-term goals haven't changed). Develop percentage allocations for each asset class, and rebalance accordingly, holding a diversified portfolio. Twelve eggs in twelve baskets is better than twelve eggs in one basket.

Keep in mind that one reason CNBC talks daily about, "How to change your portfolio based on today's movement," is because they need content that people will watch. Big advertisers on the network include major discount brokers (Schwab, Fidelity, TD Ameritrade, Vanguard, etc.) that make money when investors trade! They want you to buy and sell as much as possible. However, buying and selling all the time is a great way to consistently be disappointed. The key is to develop a long term strategy and risk need (not tolerance - more on this in a future post), and stick with it. It's not going to be sexy, but it will lead to long-term happiness from an investment standpoint.

What I've been (re)reading (and listening to):

Animal Spirits Podcast, Michael Batnick and Ben Carlson

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