Investors who alternate between chasing returns and safety wind up in the same situation as a dog chasing its tail – out of breath, dizzy, and living off of dog food. The notion that there is some strategy where the investor can perfectly time getting in and out of asset classes is bogus. A portfolio is only as effective as an investor will let it be. Too often investors are tempted to tinker, adjust, or completely rearrange their portfolios in reaction to a bit of news.
Is this you?
1999 – Can you get me in on the next IPO? Brick and Mortar is dead.
2000 – I’m going to quit my job and just trade stocks.
2001 – I am never buying stock again.
2007 – I’m going to use margin to flip a couple of houses. I saw this on TV.
2008 – Sell it all! 100% Gold! The Depression is imminent. The US is dead. Prepare for Thunderdome!
2013 – Shouldn’t I have made more than x% this year?
Reactive portfolios frequently change their asset allocation, but always hold fear and pain. Especially in today’s instant-information society, investors can feel like they are missing out. Why doesn’t my portfolio hold XYZ stock? Is it too late to get in on DRAM futures? My buddy’s mutual fund did 10% last year and my portfolio was only up 8%. Acting on the impulse to chase returns leads to bad outcomes as top performers for one year are often poor performers in following years. Investors who give in to return chasing then feel pain which leads to chasing safety. Feelings of pain impact human beings twice as much as being rewarded. While chasing safety after an undesirable outcome feels good in the short term, too often safety chasing is taken too far and the investor misses out on returns from riskier asset classes. And the cycle begins again.
A prudent portfolio, on the other hand, is indifferent to short term market movements. These investors know not to chase returns, but to let the returns come to them. Fear and pain try to make their way into the portfolio, but are weeded out through disciplined rebalancing and investor-controlled factors like expenses and taxes. The investor is in charge of the portfolio. The portfolio does not dictate action to the investor. A prudent investor’s path is a line from the present to their goals while the reactive investor is stuck in loop, their goals out of reach.
2014 – Are you in charge of your portfolio or is your portfolio wagging you?