Portfolio Management: Let Logic Prevail in your Portfolio
By Gary Silverman, CFP®
We’re about half-way through some words of wisdom I have around the subject of managing an investment portfolio. Today I want to talk about the area where I probably add the most value for my clients…but one that few hire me to do.
In the current Internet-Information age you’d think that all investors should do better. After all, anyone can find out almost everything there is to know about just about any investment. Why, then, have so many lost miserably during market corrections? A big reason is that information is useless when we let emotions interpret it for us.
Amateur investors base what should be long-term decisions on short-term information. They look at last year’s mutual fund return or a recent earnings estimate on a stock and assume the trend will continue forever. At the end of 1999 investors could look back at the previous five years and see that growth stocks had grown much quicker than value stocks. You can guess what happened—value stocks completely dominated growth stocks in 2000 and for many years hence. And, of course, they’ve flipped again…with the last many years favoring growth stocks. Back in the tech-boom, no one cared about dividends…now dividend paying stocks sell at a premium.
Taking emotions out of investing should be a major difference between amateur and professional investors. Yet sadly, even many “professionals” react emotionally to the ups and downs of the market. To be fair, most of those professionals are not really investors…rather they are experts at gathering assets from the public for their back offices to invest.
Star Trek’s Spock is one of my favorite characters. I relate to him. So when I say I can keep emotion out of investment decisions, I mean it. (Though it’s not always easy, even Spock was half human.) But for most humans, making a long-term commitment to investing in stocks is easy to say but hard to live through.
During a bull market people want me to concentrate their investments and ignore allocation principles. During a bear market people want me to dump their stocks and put everything into fixed income securities. Rationally speaking, “buying low” and “selling high” is a self-evident formula for making money on investments. But rationality goes out the window when prices fly up or plummet down. Because of this, investors have the tendency to “buy high” and “sell low.”
This departure from rational behavior occurs because investing is an emotional experience. Prices go up—people feel confident—they invest more money. Prices go down—they feel scared—they sell. This is a normal emotional response. There is no problem with feeling this way. My gut goes through the same feelings whether I’m riding a roller coaster at Six Flags or the roller coaster of the markets. The difference is that I have trained myself to listen to my mind and not my gut. One of my jobs is to help my clients do the same thing. To be successful at investing, you’ll need to learn this too.
Gary Silverman, CFP® is the founder of Personal Money Planning, LLC, a Wichita Falls retirement planning and investment management firm and author of Real World Investing