1) Turn off the financial noise machine.
Information overload is the norm in today’s world. We demand it. We expect it. Your mind, my mind, and all of our minds are wired to digest information, emotionally respond to the information, and then to do something as a result. This is why and how advertising works.
This is also how financial media works. Newsflash: most of the perceived experts talking on CNBC or writing on Yahoo! Finance are not there to help you achieve your personal long-term retirement objectives but to capture an emotional response and, resultantly, capture more eyeballs or clicks. A fellow financial advisor who occasionally gets invited to speak on financial television complains that he’s always asked to speak in soundbites about things that do not matter – how higher oil prices will impact stocks, views on the Chinese growth rate, or how recent economic data will affect interest rates.
Should he dare to talk about the core foundations of financial success – spending less than you make, diversification, patience, discipline – he knows that it would be the last of his appearances. Far more emotionally compelling is the ubiquitous explanation of what happened to stocks yesterday or the forecast for the coming year. The promotion of such noise (let’s call it what it is) is in nearly everyone’s best interest, except yours. This noise compels you to believe that you know more than others and disrupts the simple and successful process of long-term investing.
One successful hedge fund lawyer and law professor, Doug Litowitz, describes well our penchant for the financial noise:
It is not simply that we want to hear that market indexes are rising; that may or may not be good news depending on one’s positions. Rather, we want to hear that whatever our strategy happens to be, there are well-dressed, positive, cheerful and confident people telling us that destiny is in our hands, and that the dream is within reach.
No one wants to hear that we are throwing hard-earned money to the cruel winds of malevolent and opaque forces, that billions, even trillions, are sloshing around vulnerable to unstable geopolitical and sociological events that defy rationality, or that fortunes can be won or lost because of some freak tragedy.
No one wants to hear that the market is propped up by the Federal Reserve, or that we are irrationally exuberant, or that earnings guidance is low-grade fiction.
We want to be reassured by serious men and women in suits who tell us that events are looking up, that problems are solvable, that the market is rational, that we are scientists, not gamblers.
And most important, we can all be winners if we just listen to their experts on shows like Fast Money and Mad Money. Just as the audience at a magic show suspends disbelief while the magician saws a body in half, the CNBC viewers suspend disbelief about whether the ‘experts’ on the screen were correct yesterday, or the day before, or the month before.
Do yourself and your family a favor and turn off the financial pornography. Don’t convince yourself that you’re only watching it for entertainment or that you won’t act on it. Just turn it off. Your spouse, your children, and your future self will all be far better off for it.
2) Throw away the keys.
Last summer, professional golfer Rory McIlroy decided he was done. Done with social media. There was the negativity, the trolls, and, importantly, the distraction from focusing on his profession. But he didn’t just commit to stop checking social media accounts. He took the bolder step of turning over all his passwords to his new wife and telling her, “change my passwords to something else and don’t tell me what they are.”
As wild as this concept may sound for investors, it presents a practical and financially beneficial solution. Hand over the passwords for your investment accounts to your less-apt-to-check-the-statements-spouse. If you are reviewing your investment accounts every month, what benefit are you getting from this exercise? What about every week or, worse yet, every day? Do you make any productive decisions based on the updated information? And is it really informative?
Ups and downs are an inevitable result of investing. But short-term movements are based on emotion, noise, and rumors whereas only in the long-run are investment movements based on earnings and facts.
When you check your investment accounts frequently, you will more often feel a need to do something. This is the way your brain and all of our brains are wired. There’s an urge to sell investments after bad performance or buy more investments after good performance. Moreover, we empirically feel less regret if we take action than if we do nothing. As the Astute Angle explains here, this is the reason why soccer goalkeepers dive left or right on penalty shots even though there is significant evidence to suggest that they would win more often by staying in place.
It’s not that you’re financially irrational. It’s that all of us are financially irrational.
Loads of evidence indicates that the more frequently investors review their accounts, the worse they perform. Why? Again, because investors who view their accounts more frequently are more likely to act and action tends to be counterproductive to financial success. Researchers Terrence Odean and Brad Barber were given access to anonymous transaction data from thousands of accounts at a discount brokerage firm. Among other eye-opening discoveries, they found that the stocks that investors sold outperformed those they kept by 3.4% over the next 12 months.
Or consider the findings from a study of accounts at Fidelity Investments. They separated investors into deciles based on how frequently or infrequently they logged in to view their accounts. You probably know by now what they found. Investors who logged in most often were the worst performing decile. The best performing investors never viewed their accounts. When the auditors called the owners of these best performing accounts, the overwhelming majority had either switched jobs and forgotten about an old Fidelity 401(k) or the investor had died and the assets were frozen in an estate.
Perhaps you can’t learn to hit the golf ball like Rory McIlroy. But you can steal a page from his strategy to deal with what matters and tune out what doesn’t. Automate your investment savings, employ a diversified portfolio, and then handover the keys.
3) Have a written plan.
Research finds that people who work with comprehensive financial planners are more financially successful that people who don’t, controlling for externalities like wages, race, gender, or demographics. The biggest contributor to this financial success is not investment returns, stock selection, or better tax efficiency.
People who work with advisors are simply more disciplined and that’s the biggest contributor to their future financial success. They’re more disciplined about their savings which, conversely, makes them more disciplined about their spending. They are not just investing money and trying to achieve a market-beating return. Their plan is not to see how the market does and then make a decision on when or how much to invest. Instead, they have a written investment plan that establishes, in advance, how much of next year’s bonus will be invested or the asset allocation of their portfolio.
This is to say that developing a written investment plan and financial plan that you will stick with through good or bad markets will likely be of far greater value than deciding which mutual funds to purchase. Writing down a plan then helps create a discipline – perhaps the systematized investment of money at regular intervals or the structure that determines when a fund is rebalanced.
Ever written down your goals or New Year’s resolutions? Maybe you did not reach the goals or keep the resolutions. But empirical evidence shows that just the simple exercise of writing them down dramatically increased the probability of you achieving them.
So maybe you write down your investment discipline and still deviate from it when markets are plummeting. But if you are far more apt to stick with a written plan, what’s the harm in writing one down?
4) Know your limits.
A college basketball coach recently explained that his most successful basketball players were not necessarily those with the greatest skill. Instead, his most successful players were those with the greatest self-awareness. They understood their abilities, their weaknesses, their limitations, and they then used that self-awareness to best define their role on the team.
Success in investing similarly rewards self-awareness. The reality is that we humans are lousy at prediction but many of us convince ourselves otherwise. Our inherent behavioral biases cause us to make bad decisions and to look for meaning when there is none. For example, robust behavioral research demonstrates that human brains have trouble comprehending probabilities and so our natural bias is to overweight low-probability events. Additionally, we are seduced by elaborate stories more than by simple probabilities and so we rely on such stories when making investment decisions rather than on the more useful and simple probabilities. All of this tends to make for terrible investment decision making.
The successful investor is self-aware. He is humble enough to recognize that his brain is wired to make poor investment decisions and takes steps to avoid emotion-saddled decisions. She appreciates the Grand Canyon sized divide between speculation and investing. But more than that, the successful investor recognizes his or her predisposed risk tolerance, understands that this risk tolerance may be very different from that of a friend or work colleague, and invests at all times with a level of risk that is appropriate to his or her personal risk appetite.
What are your thoughts on these 4 strategies? Have other suggestions or questions? We invite you to leave any comments, questions, or ideas in the comments section below.