Every year there are studies that discuss why investors underperform in the markets. Dalbar’s QAIB, Morningstar, BlackRock and others present data that show the average investor often buys high and sells low.
In that regard, here’s an attempt to distill some of the more common errors I have seen as a financial adviser.
The biggest mistake I see in an investment plan is when there is a disconnect between the investment manager’s strategy and the investor’s understanding of how that strategy should perform in different market environments. Problems can arise when the market is up and a complex strategy is not. This may be due to legitimate management issues, but many times it’s because a strategy is out of favor.
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Like markets, strategies can be cyclical, going through periods of highs and lows. Investors often are drawn to complicated strategies based on past performance and purchase them toward the height of a cycle.
An additional problem with some complex strategies is that they often are not grounded in the reality of being a part owner in a business, sector or asset class. When their strategy is out of favor at the same time the market is up, an unknowing investor may sell low for the wrong reasons.
A more sensible core investment strategy for most investors might be one that is easy to understand, simple to implement and more correlated to the market. With a sensible core, the investor can use these other strategies on the margins for diversification purposes while having their personal results more aligned with what they are hearing and reading day to day.
Generally speaking, my experience has been that successful investing is goals-based and plan-driven. Most of the failed investing I have observed is market-based and performance-driven.
Most people are investing for long-term needs such as retirement income and legacy plans. Current news in the world, the economy and the markets are more often a distraction from these longer-term goals.
Case in point: Wells Fargo, which yields just under 3 percent. The company announced its cross-selling issues in August and promptly dropped more than 13 percent by mid-October. A market-driven investor would have had a hard time making a case for holding the position and likely sold out. The goals-based investor would have additional criteria such as yield and other qualities that could have kept them invested and ultimately rewarded for their patience.
The more we focus on performance rather than process, the more reactionary we become to economic and market news that often leads to buying high and selling low.
In December 2013, I wrote a piece in the Herald on Alabama football coach Nick Saban and the power of process. In it I quoted him as saying, “The more one emphasizes winning, the less he or she is able to concentrate on what actually causes success.”
The same is true in investment management. The more we focus on performance rather than process, the more reactionary we become to economic and market news that often leads to buying high and selling low.
Sticking to the past
Life is full of transition points, each of which comes with investment challenges. Whether you are a new parent or in retirement, there are time-tested strategies that are tailored to your situation. There is no one-size-fits-all approach to investing, and investors should be open to adapting strategies to fit their objectives.
A good example: Someone who is investing for future needs, such as retirement, versus someone who is investing for current needs, such as a retiree. There are many ways to build a nest egg, most of which will work. Most of those ways don’t work so well once you start living off your nest egg.
Dollar cost averaging, for example, can help better employ dollars into an investment program. When market returns are down, you benefit by buying more shares for the same dollars. That same method in reverse for distributions means you draw down more of your resources in a down market.
Adopt a standard of care that applies to your situation in life.
A wise friend said never buy anything from someone who has a lot of charisma. His point was that they often rely on their skills of confidence rather than competence. I would reverse it to say only buy services from those with empathy and good bedside manner.
When markets get chaotic, clients need to feel heard and understood. A caring adviser can act as an emotional circuit breaker that allows the client to reassess their situation in a more objective manner.
Vanguard Investments published a paper on the value of advice called Advisor’s alpha. In it they focus heavily on empathy, or what they call behavioral coaching. An empathetic adviser can act as a sounding board to help address the issues discussed in this writing.
Gardner Sherrill, CFP, MBA is an independent wealth manager with Shoreline Financial Partners. To learn more, visit www.shorelinefinancialpartners.com.