Mental constructs that could hurt your investments and your wealth
By: Robert DeVries
Do any of the statements above look familiar? Have you ever thought them? Each of those thoughts and a few more below, could lead you to poor decision making about your investments and wealth. Below, we cover three more common mental constructs that could be a roadblock and strategies to overcome them. In my last blog, we covered three others – illusion of control, anchoring, and confirmation bias.
Let your winners run is an old adage, but it can hurt your portfolio. Unsold positions become over weighted in the portfolio, changing the risk and return dynamics of a well-constructed portfolio.
What’s happening: Recency bias. Our brains tend to think what happened in our recent experience is a baseline for what will happen in the future. What is more likely is revision to the mean and asset class rotation.
What you should do: Maintain your asset allocation and portfolio weightings. By trimming your position to your target portfolio weight, you are trimming assets that have done well (sell high) and buying asset classes that have done poorly (buy low). If the asset class continues to perform well, you still own it in your model weight, but if it turns down, you’ve trimmed its exposure back to your intended weight.
Equity markets have had two good years and many are at all-time highs. You are fearful of getting in after a market high and you sit on the sidelines with cash.
What’s happening: Myopic risk aversion. Stocks go up over long periods of time, so focusing on the short term can cause you to miss out on equity performance while waiting for the ‘right’ entry point.
What you should do: Invest money with long term horizons in equity markets. There is no actionable information at an all-time high. Research shows1 that there is a similar percentage chance that a market is up after 12 months following an all-time high as at any other index level. So the best time to invest is when you have the capital to do so and the time horizon to let it withstand short term volatility.
You can’t stand to hear about the great investment that everybody is talking about having made money on. Does Bitcoin ring a bell?
What’s happening: Herd mentality. You don’t want to miss out on what others are doing, but are you one of the birds in formation or a lemming about to go off the cliff?
What you should do: Invest capital wisely both through diversification and asset allocation. Capital should be deployed toward your goals, matching your time frame for investment with the risk associated with those investments. For example, if you have only 12 months before you need to meet an obligation, you would not want to invest in a 100% equity portfolio. Rather, equity investments should be made when the time frame is significantly longer.
FirstWave Financial can help you work through these thoughts. For more, please call our wealth services firm in Satellite Beach, FL – Melbourne/Brevard area at (321)773-7773 to schedule a complimentary consultation or visit us at www.firstwavefinancial.com.
You should not assume that any discussion or information contained in this publication serves as the receipt of, or as a substitute for, personalized investment advice from FirstWave Financial. A copy of the FirstWave’s current written disclosure statement discussing our advisory services and fees is available upon request.
1New Market Highs and Positive Expected Returns, Dimensional Fund Advisors, January 2018