Tim Decker//November 15, 2019
Tim Decker//November 15, 2019
Successful investing is only one percent intellectual and 99 percent behavioral. Even if you think you know what you’re doing as an investor—the intellectual part—you still face a huge challenge in the area that matters the most: the behavioral department.
This is where even highly intelligent, educated individuals often go wrong, as they lack the discipline needed to construct and consistently maintain a sound, diversified investment portfolio. Without this discipline, a portfolio can easily go off the rails. Warren Buffett pointed this out when he said: “Success in investing doesn’t correlate with IQ … What you need is the temperament to control the urges that get people into trouble.”
Many get into trouble by over-reacting to market fears, selling in a panic and then, driven by greed, chasing past performance by investing in what has recently been performing well. Academics in the field of behavioral finance refer to this as recency bias—extrapolating future performance from recent past performance. This is a mistake because an investment’s future performance is more likely to resemble its long-term past, not its recent past. (This is known as reversion to the mean.) If you invest this way, you’ll likely be perennially buying high and selling low; the opposite of what you should be doing.
Investing for retirement and other goals means carefully formulating a thoughtful, focused plan that reflects your goals and risk tolerance—and, above all, sticking with it. If you lack the discipline to ignore market noise about short-term fluctuations — noise that’s irrelevant to capturing long-term market returns — you’re prone to financial self destruction. Instead, you need an unemotional process in place to protect you from yourself so you can stick to your financial plan.
This financial plan should be written down, purposefully designed and driven by your specific goals and tolerance for volatility. Also, your plan should account for the inevitable market declines that will inevitably occur during your lifetime.As the dangers of behavioral risk have a tremendous impact on your future financial security, taking behavioral risk out of the equation is the single biggest reason to work with a trustworthy, experienced financial adviser. A qualified adviser can help keep you on track and serve as your coach by keeping you from making rash moves, which don’t reflect what Buffett referred to as the right investing temperament.
Maintaining discipline improves long-term returns while helping keep risk in perspective. And for the vast majority of investors, a good adviser can help you do better in the long run, studies show. A 2018 study by Vanguard found that using an adviser can increase your net returns over time, after paying the adviser up to 3 percent annually. The study refers to this gain as the adviser’s alpha, or added value.
Of course, this assumes that these advisers aren’t charging high fees and commissions, and that they’re free of conflicts of interest. Ideally, you want an adviser who is paid by you alone and is a true fiduciary — one who always puts your interests ahead of their own; this is crucial. Also, be certain that the adviser’s investment philosophy and strategies are evidence-based–supported by objective academic research.
Experienced advisers usually have much more discipline than their clients. Numerous studies by Vanguard, Morningstar and other institutions have concluded that some of the value experienced advisers can deliver stems from providing time-consuming portfolio rebalancing, the use of tax-saving asset location strategies, designing portfolios and assisting you with retirement withdrawal strategies. These services, along with all-important behavioral coaching to prevent self-inflicted wounds, enable skilled advisers to earn your trust while earning their fees.
Ultimately, by working closely with the right adviser, most people can improve their net returns and reduce risk from their own financially destructive behavior. Thus, they’ll be taking care of the intellectual part of investing while helping you avoid the perils of the behavioral part.
Tim Decker is president of ISI Financial Group, a wealth management firm in Lancaster, and a fee-only financial planner (he sells no products). His weekly call-in radio show, Financial Freedom, airs Saturdays at 10 a.m. on WHP580 AM.
This content is based upon information believed to be accurate by ISI Financial Group, Inc. However, it is not intended to provide specific financial advice. You should always seek professional guidance before making any financial or legal decisions, as everyone’s needs are different.