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Archive for March, 2016

19
Mar

When investing should you follow your gut?

Jason Zweig’s Wall Street Journal March 18, 2016 article, “The Three Worst Words of Stock-Market Advice: Trust Your Gut” is insightful.  The substance of the article is stated in a quote from Benjamin Graham’s book, “…The investor’s chief problem-and even his worst enemy-is likely to be himself.”

The article references research by “…finance professors William Goetzmann and Robert Shiller of Yale, along with Dasol Kim of Case Western Reserve University, have analyzed the Yale surveys and found that investors’ forecasts regularly look more like aftercasts—simple projections of the recent past into the future.”

“Prof. Shiller… has been surveying investors about their expectations since 1989.” One question is…What are the odds of a one-day crash of at least 12% in the U.S. stock market over the next six months? The probable answer was about 10 times the probability. “Remarkably, professional investors exaggerate the odds almost as badly as individual investors do.” “What’s more, the new study suggests, you probably should have put higher odds on an imminent crash back in January than you would now or would have six months or a year ago. That is partly because a sharp recent drop makes future declines seem more probable, and partly because the news media uses words like “crash” much more often after the market falls sharply.” “Naturally, investors tend to be complacent when they should be worried and afraid when they should be optimistic.”

“Words charged with negative emotion not only darken your view of the future, but they may make you feel that riskier investments have a lower—rather than a higher—potential return.”

“Dates like Oct. 28, 1929, and Oct. 19, 1987, when the Dow Jones Industrial Average fell 13% and 23% respectively, can “evoke a sense of doom,” says Prof. Goetzmann of Yale. ‘Crashes have a remarkably long life in the public imagination. Their echoes can last for decades’.”

Having a plan with a target allocation can help restrain reacting to your gut.  This provides a map to achieve your financial goals.  Your plan should be reviewed when your goals, priorities or circumstance change.  You should review your investments periodically to see if they still fit the reason you chose the investment.   There is not a consensus of how frequently you should review your plan and investments. Making changes too frequently is trading rather than investing.  Very few are consistently successful at trading.  There are costs and possible tax consequences when trading. Your plan should identify when the investment should be adjusted to meet your target (rebalancing). Set a percent or dollar amount of change that would justify rebalancing.

Generally rebalancing will increase the long-term performance.  Waiting too long can reduce your returns.