Irrational Behavior Causes Americans to Underperform as Investors
Are you a casual or average investor who takes pride in the diverse portfolio you have built? If so, hold your celebrations. The most recent edition of the famous Dalbar “Quantitative Analysis of Investor Behavior” report suggests that Americans are actually terrible at investing. The reasons may surprise you. Most investors think that underperformance of portfolios can be attributed to high fees charged by frequently used index funds or investment advisers. Popular opinion also blames trends like “investing to hold” or holding on to stocks. According to the Dalbar 2017 study, the primary reason for investor underperformance in America is none other than behavioral biases. Behavioral biases come as a cluster, so the problem can be summarized as irrational behavior driving bad investment decisions. This may come as a shock to average investors, who may take steps to avoid the kind of conduct the study describes. However, behavioral biases can still affect us in ways we barely, if ever, notice. Dalbar identifies “jumping into and out of investments every few years” due to overall impatience as the main reason why investors underperform. This lack of patience is not necessarily driven by bad decisions, but rather by irrational decisions arising from behavioral biases.
Narrow framing is a bias that causes you to make investment decisions focusing only one aspect of your portfolio. Remember that even the smallest investment action affects your entire portfolio, so when you don’t take this overall effect into account, your portfolio may underperform. To overcome narrow framing, consider every single one of your investment decisions with the big picture in mind. For example, when you research stocks to buy now, understand how the newly purchased stocks may affect another asset in your portfolio. Once more, keep your eyes on the big picture.
Fear of Loss
Americans are surprisingly loss averse. It’s a particular form of paranoia that causes investors to start selling perfectly viable stock. Several factors can lead to fear of loss that causes this behavior. For example, Americans are highly likely to react to emotional triggers in headlines or promotional material. If you see a negative article in a newspaper or a blog shared on your Facebook feed, it might cause you to panic about a company and start selling stock.On the plus side, it’s not impossible to overcome loss aversion that costs money. You can learn to read the news more objectively. Instead of reacting to negative articles in an instant, take time to get a clearer picture of the story.
Anchoring refers to framing your thought process based on what took place in the past. The market is always changing. While the past could be an important reference point, don’t expect history to repeat itself precisely within a business framework. Your frame of reference must evolve and adapt to the newest realities of the market. Anchoring was one of the issues that brought down Long Term Capital Management, once considered a highly promising hedge fund staffed by Nobel laureates in economics. Don’t let the same fate befall your investment portfolio.