Sticking to a plan in the face of emotional volatility
- April 16th, 2013
Much has been written about the crash, for lack of a better term, in the gold market over the past couple of days. Whenever we get a sharp, swift move the markets it induces a great deal of anxiety for investors. This anxiety causes them to abandon whatever plan they had in place just a few short days ago. This pinging back and forth between strategies is a recipe for disaster. How can we avoid this? Carl Richards at the NYTimes writes:
The big mistake is usually part of telling ourselves one of a number of stories. These stories are carefully constructed to persuade us that our long-term, rational plan is no longer valid…
So what can you do when you find yourself believing any of these stories? Hit the brakes for a second and remind yourself that only one story matters. Unfortunately, it’s a very boring one: the key to investing success is having a diversified, well-designed plan and sticking to it for a long, long time.
One of the great services financial advisers provide to investors is to an emotional buffer between the client and the plan. In an interview at AdvisorOne Phil Pearlman said:
“As an advisor, you have to have had a plan laid out with your client, you have to have a strategy in place and at times like these, you’ve got to sit them down and get them to understand the rationale of that plan, its goals and why it was set up in the first place,” he says.
Doing that not only requires levelheadedness on the part of an advisor, it also calls for empathy, Pearlman says. If clients are to buy back into the rationale of their financial plan at times of extreme stress when their rationality is thrown off balance, then advisors need to have formed a good relationship with them, one that is based on trust, understanding and responsibility that has been cultivated through time.
For both the self-directed investor and the advisory client having in place some mechanical rules that take some of the decision making out the discretionary arena and into an automated one can make sense. James Picerno at the Capital Spectator had a post up a few weeks ago talking about the benefits of portfolio rebalancing. However in light of the turmoil in the gold market an even more recent post shows how a systematic approach to rebalancing can help us offset some of market-induced emtion. Picerno writes:
As for gold’s latest tumble, and the bearish aura it seems to have cast over oil and other commodities, the sharp drop in price represents an intriguing opportunity for those of us who continue to embrace the fundamental strategy of prudently diversifying across the major asset classes and rebalancing the mix regularly. No wonder that a simple application of these two crucial techniques in portfolio management tends to perform competitively against a wide array of strategies intent on doing better.
Why? There are several reasons, although it starts with the fact that markets have a habit of surprising even the smartest investors with sudden bouts of volatility. That’s never going to change, which why broad asset allocation and routine rebalancing are likely to remain perennial winners in relative if not absolute terms.
That is the attraction of Norway-like strategies that emphasize diversification and portfolio rebalancing are so attractive. By simplifying the portfolio process they reduce the number of decisions we make it increases the chance that we stick to our original plan. I have written it many times but having a plan, even a sub-optimal one, that you can stick to is preferable to having no plan at all. The ongoing challenge for advisors and investors alike is to find a plan that they will not abandon at the first sign of trouble.
Items mentioned above:
To avoid the biggest investing mistakes, stay strong. (NYTimes)
Overcoming your clients’ emotional volatility. (AdvisorOne)
A smart way to look at a “dumb” investing strategy. (Capital Spectator)
Another golden lesson for asset allocation & rebalancing. (Capital Spectator)
Focus on Norway, not Cyprus. (Abnormal Returns)
Choosing simplicity as a default. (Abnormal Returns)
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