Market turbulence shouldn’t derail your long-term asset allocation, although you might want to tweak it.
Here's advice from two experts on how to be a smart investor.
Vitaliy Katsenelson, Chief Executive Officer at Investment Management Associates, on how to be a rational investor.
Investors are prone to two opposing but equally debilitating fears: the fear of missing out when times are good, and the fear of loss when markets are volatile. These two fears have a zero-sum relationship with rational decisions. The more you are dominated by these fears, the less rational you are.
So what can we do, as investors, to move toward maximum rationality? Here’s one piece of advice: Don’t constantly watch your portfolio.
Next time you notice the price of a stock you own moving up or down, think about the factors that may be influencing that move. Stocks are owned by people who have very different time horizons. You’ll have mutual funds and hedge funds whose clients often have the patience of 5-year-olds. They are getting in and out of stocks based solely on what they expect them to do in the next month or six months – a rounding error of a time period in the life of a company that lasts decades.
Some buyers and sellers are not even humans but computer algorithms that are reacting to variables that have little or nothing to do with fundamentals of the company you invested in – these players have a time horizon of milliseconds.
You will also have folks who are buying and selling a stock based on the pattern of its chart. Not that they don’t know what the company does; they will tell you they don’t care what it does. For them it’s just a chart with one squiggly line crossing another squiggly line.
Then there are folks who spend more time researching the next movie they are going to see than the stock they’re about to buy. Some of them buy a stock after reading a single article on the internet, while many others buy on the advice of their brilliant neighbor Joe, the orthodontist.
If you are a fundamental investor, you are not just buying stocks, you are buying fractional ownership in businesses.
You spend hundreds of hours on research, you read company financial reports; you talk to management, competitors, customers, suppliers. You build a financial model that looks years into the future to value a business, and also to predict what could kill it.
If after you’ve done all that, you still find yourself glued to the computer screen watching the price change tick by tick, you are basically giving credence to the idea that what a company is worth should be decided by algorithmic funds, the guy who reads charts but cannot even spell the name of your company, Joe the neighbor, and an ETF with the IQ of a Halloween pumpkin. (I don’t want to insult everyday pumpkins here.)
In short, the less time you spend looking at your portfolio, the more rational you are going to be.
Christine Benz, Morningstar’s director of personal finance, advises investors to opt for a policy of benign neglect, as against frequent monitoring and rebalancing tweaks.
Assuming you’ve taken care with your starting asset allocation and have selected high-quality investments to populate your portfolio, too frequent monkeying around could lead to worse results than sitting still.
Trading also has the potential to jack up costs, both transaction and tax costs, which drag on returns.
Another reason to take a hands-off tack with your investments is to keep your stress level down.
If you limit your checkups to a simple annual review, you’re less likely to sweat small market movements because you won’t see them reflected in your net worth.
