Numerous studies show that the biggest barrier to good investment returns is investor behavior. The biggest problems with investor behavior tend to be emotionality and lack of patience. Focusing on a time frame that is too short typifies the patience issue. Investors should be prepared to carefully select a strategy that is likely to generate excess returns and then stick with it for a minimum of five years without touching it. Ten years is even better and probably more realistic.
Keeping hands off a portfolio is made difficult by the emotions that market gyrations can create. In Wall Street parlance, these emotions are typically referred to as fear and greed. When you look at psychological studies, however, greed is a much, much less powerful motivational force than fear. (Perhaps my background as a psychology major has cursed me to care about precision in these matters!) Tom Petruno’s column in the Los Angeles Times is the first one that I have seen for a long time that I think correctly categorizes the emotions that most investors feel: not fear and greed, but two kinds of fear. He writes that “a desperate fear of losing is what fueled the tidal wave of selling in the stock market last winter. Now, a desperate fear of not winning is pushing investors back to risky assets, maybe far too quickly.”
The other nice thing about his article is that he considers the only two realistic possibilities for avoiding fear and desperation at market turns. One possibility is to create a portfolio mix conservative enough to keep from panicking during difficult environments. That suggestion has merit, but when done realistically—investors often imagine they can handle more volatility than they really can—the allocation is so cautious that the long-term returns are not always satisfactory. The other realistic possibility is to remain flexible about buying and selling different asset classes as they move in and out of favor. This is the model on which our Systematic RS Global Macro portfolio is built, for example.
Whichever way investors decide to go, they need to think it through before they are in the middle of the storm.
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