I wrote this post a couple of years ago, but the ideas here still hold true. In some respects, they're even more apt now than they were then. As we approach the New Year, it's a good time to examine our portfolios (and our lives) and ask ourselves what we could be doing better. — Brad
A while back, I clicked on a link to a Forbes piece, 35 Questions That Will Change Your Life. I’m a sucker for this type of article, even though there’s usually not much there, but this time I was surprised. Many of the questions were original, provocative, and, frankly, difficult to answer without some serious introspection. Several of them are also particularly applicable to investing.
1. What are you pretending not to know?
This question speaks to the challenge of applying knowledge, rather than emotion, to investment decisions. For example, many people know that a diversified portfolio can be a key to long-term success, yet many still succumb to the urge to chase performance. I’ve heard from dozens of investors lately who want more exposure to U.S. stocks and less to international, since domestic names have done so well over the past couple of years. Although we know that the best time to buy is not after an extended run-up, the temptation is real.
We typically pretend not to know something because it’s simply too painful to face—or because the consequences of knowing are worse than the consequences of pretending not to. In both cases, in investing, the pain of doing the right thing is, over time, much less than the cost of not doing so. We need to find a way to act on what we know rather than acting as if we don’t.
2. Why don’t you do the things you know you should be doing?
The secret to increasing your potential investing success is actually no secret: diversify and rebalance. That means you end up selling high, on average, and buying low. It can also mean getting out of investments that make you feel good and into ones that scare you. This alone explains why most of us don’t do what we should, as well as the current investor interest in U.S. stocks.
There are a couple of ways to take away the pain of making hard decisions:
- Have someone else (i.e., a financial advisor) do it.
- Or, if you want to do it yourself, set rules and schedules. If you have rules, there is no decision; just follow them.
A similar rationale is at work in default savings and retirement plans, which take advantage of people’s laziness. If you have to opt in to retirement savings at work, you may never get around to it. If you instead have to opt out, you still might not get around to it, but you'll be saving as a default. You can set up systems like this for yourself—for instance, by using direct deposit to send part of your paycheck to a savings account rather than your checking account, where you'll be more tempted to spend it.
Make a one-time effort, and then use today’s laziness to your own future benefit.
3. Should you be focused on today or tomorrow?
You have to focus on both, and the ideas I outline above can help you maintain that balance. By putting your savings on auto-pilot, you’ve started to take care of tomorrow. By rebalancing automatically or on a rules-based system, you’ve created a framework that, for the most part, helps tomorrow take care of itself while you devote most of your attention to today—which is where it should be.
As I get older, I realize that what success I’ve had has been largely a matter of learning to work around my weaknesses and flaws, while taking advantage of my strengths. Particularly in matters of investing, we all share basic flaws—loss aversion, unwillingness to take gains, short time horizons—that limit our chances of success.
The questions here highlight how that damage is done and also point the way to reversing it, making your success over time much more likely.