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February 10, 2012

You may not realize that our brains may not give us the best answer.

Returns realized by investor are lower than the returns of the funds they own.  This was a frequent observation of the  Fidelity Magellan Fund when Peter Lynch manged it (1977-1990).  Morningstar  statistics of fund returns and of the returns realized by investors continues to find that investors’ returns are lower. 
This topic is the subject of numerous studies.  Generally investors buy when the market goes up.  Then they sell when it goes down.  The result is that securities are bought high and sold low.  The opposite of what should be done. 
Jason Zweig discusses this subect in his February 11th article in The Wall Street Journal.  He references seven surveys since 2008.  “These surveys have shown that investors’ forecasts of future returns go up after the market has risen and down after it has fallen.”  “The investing mind comes with built-in machinery that sizes up the future based on a surprisingly short sample of the past.”
He suggest some things we should do to minimize our overreaction to market fluctuations.  The first hing is to pause and reflect how you reacted to past fluctuations.  Ask your self how accurate you were.   Next you should develop some”solid reasons” the market is under or over valued.  Keep a record of reasons so that you can look back and see how accurate you were. 
He suggests that investors not rush to action based on the current activity of the market.  Investors should be patient.
I believ investors should have a plan and understand it.  Their portfolios should be constructed so that they do not have to react to the short term fluctuations of the market.  Portfolios should have enough invested that they can live for a time without having to liquidate parts of their portfolio because of market fluctuation. 
If you view the daily fluctuation as static, you realize you should not be looking at your investments too frequently.

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