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The year is still young. We have time to incorporate self-improving habits that will become second nature by Dec. 31.
Just as important, we have time to break bad investing habits.
The following five investing habits are best broken sooner than later. The sooner you break these habits, the sooner you’ll improve your investing results.
1. Chasing Last Year’s Winners
“What worked yesterday is guaranteed to work tomorrow, and forever thereafter.”
No, it’s not. Change is constant. Investors continually cycle out of one investment class and into another. Many investors jump into the hot investment class, the one with the best past performance, just as that class is set to cool.
Data from the St. Louis Federal Reserve show that chasing hot stocks imparts real damage. From 2000 through 2012, the return-chasing investors in mutual funds realized a 3.6% return. The buy-and-hold investor, on the other hand, realized a 5.6% return.
Stocks that have soared to the stratosphere eventually return to earth (see Apple Inc.). Stocks that have cratered eventually emerge from their hole (see General Electric).
Contemplate how the future can change, not how the present will extrapolate.
2. Misunderstanding Performance Information
We’ve all seen the advertisement: “Our fund has beaten the S&P 500 over the past five years.” Parse the fine print, and you’ll find: “Past returns are no guarantee of future performance.”
An investment that has outperformed the broad market over the past five years is as likely to underperform over the next five years. Investment styles cycle up and down.
We have one exception.
Investing for income and dividend growth has proven to increase wealth over time. Look no further than dividend aristocrats McDonald’s (NYSE: MCD), T. Rowe Price (NYSE: TROW), and Altria Group (NYSE: MO).
3. Excessive Trading
Many investors are obsessed with action. They fail to account for the expenses actions impose. Traders incur higher commission costs and higher taxes compared to buy-and-hold investors.
Even the rare few who win enough to cover the higher costs are unlikely to win.
An investment study published in 2000 showed that individual investors paid a steep performance price for hyperactivity in their investing habits. The study focused on 66,465 households with accounts at a large discount broker during 1991 to 1996. Those who traded most earned an annual return 6.5% less than the overall market during the period.
4. Thinking Investing Is Easy
Stocks have a very high noise-to-signal ratio. Meaningful information is conflated with a lot of nonsense. Analyzing stocks requires work. Investing is a business, not a hobby. We are competing against a slew of other investors.
Successful investing is hard.
It is wise to approach investing as the professional poker player approaches the poker table. You need to know more than the basics to succeed. Yes, you will win a few hands out of luck, which will keep you coming back, but the odds will eventually work against you.
Don’t allow yourself to underestimate the difficulty. Approach investing as a disciplined business venture and you will minimize the gambling aspects of investing and increase your chances of long-term success.
5. Obsessing Over Your Portfolio
The internet provides ceaseless access to portfolio monitoring. Investors check their portfolio daily, if not hourly. That’s not a good thing.
Nassim Taleb, author of Fooled by Randomness, offers an insightful example of the pitfalls of continual monitoring.
Taleb’s example centers on an outstanding investor who earns 15% returns annually on a portfolio with 10% price volatility. This means that in one year the investor has a 93% probability of success.
If the investor monitored his portfolio only annually, odds are high – at 93% – he’ll experience pleasure (and success).
The more he monitors, the more likely he’ll confront negative information. The outstanding investor in Taleb’s example has a 46% probability that he’ll run across negative information (and thus pain) if he monitors his portfolio daily.
The negative registers twice as much on the brain as the positive. The more you monitor, the more likely you will encounter negative information. More important, the more likely you are to act on the negative information.
Break the preceding five investing habits in 2019 and you’ll enter 2020 a more competent investor.