Ignoring the temptation to second guess investment decisions improves results. Here is an example.
The stock-picking newsletter, Closed-End Country Fund Report, stopped issuing new recommendations in mid-2004. But because the editor said he might resume publishing at some point in the future, Hulbert's Financial Digest left its last picks active in their database. For those of you unfamiliar with Hulbert's, it is a service of Dow Jones that has tracked newsletter performance since the mid-1970s.
A funny thing happened. The dormant newsletter's picks have gained 139% since it stopped publishing, it was one of the top performers of 2006 and it has the best five year performance among all newsletters tracked by Hulbert.
There are important lessons here for individual investors. Amateurs and professionals alike are affected by fear and greed. When you decide to change course, in mid-stream, it is rarely a logical decision. More likely you are being driven by fear or greed. Fear and greed make terrible portfolio managers.
Mark Hulbert, the found of Hulbert's Financial Digest (and a previous guest on my radio show) does an exercise to prove this point. Each year, he takes the picks of newsletter writers at the beginning of the year and figures out the return if they had stuck with those picks rather than fine-tuning throughout the year. In every year, the newsletter writers would have done better by going with their original game plan.
In 2006, for example, the average newsletter portfolio gained 11.35%. Had they stuck with their picks from the beginning of the year, their results would have been 12.15%. When you factor in the tax consequences of the transactions, the results would have been even more favorable if they had gone with their original plan.
Similar exercises have been done for mutual fund managers and individual investors with similar results. Time and time again, study after study says fear and greed cause us to buy high and sell low. We become convinced that we could do better elsewhere and we get the exact opposite result.
An article by Mark Hulbert on MarketWatch recognizes the difficulty we all face:
None of these results denies that doing nothing can be psychologically difficult. Holding a stock that is falling takes courage, just as it can seem irresistible to jump on a stock that has already risen.
If it was easy, we would all make a lot more money and they would have to take very few coaching calls at Chronim Advisors. I don't think anyone, especially me, is suggesting you completely ignore your portfolio. That can be equally bad. But you have to strike a middle ground.
But what these results do suggest is that we should place a large burden of proof on making a change in our portfolios. Unless the arguments in favor of such a change are particularly compelling, we probably should simply do nothing.
The most important thing you can do as an investor is to be consistent. In other words, you must make investment decisions when you are sane - when you have not put any money at risk - and stick with them when you become clinically insane - which is the moment you invest a dollar in a security. From that point on, you are not competent to make logical decisions.
The way to circumvent that is to make all the decisions up front and never on the fly. Now you might be thinking to yourself, but what if new information becomes available that I didn't have in the first place?
Remember, 99% of what you hear is noise, not signal. Pros may be able to distinguish between noise and signal but you can't. The probabilities will work in your favor if you can teach yourself to ignore it.
Throughout the history of financial markets, the investors that have done best are those that can manage their portfolio, and their emotions, with unflinching discipline. If you listen to noise, change course mid-stream, and constantly second guess your investment decisions, you will probably not be very successful as an investor.
But the good news is this is a learned skill. If managing your portfolio well is a priority for you - and who can afford for it not to be given our need to fund a thirty year retirement - moving from a fly by the seat of your pants mentality to a disciplined approach will make a big difference.
SOURCE: (Direct quotes are highlighted)
1. Mark Hulbert, "The Value of Doing Nothing"; MarketWatch.com; 19 Jan 2007
Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.