Four Common Mistakes Investors Make When Reviewing Their Performance
Discussing investment performance with friends, colleagues, or neighbors is a lot like the world of social media. Similar to social media, where people tend to accentuate the positives and downplay the negatives, when discussing investments there’s a tendency to talk about the winners (owning Amazon since its IPO, owning Bitcoin during 2017, etc.) and downplay the losers. Given this dynamic, and with all the noise from the media about the latest “hot” investment, it can be difficult to put your own investment performance into context. Before explaining the right way to think about investment performance, we first want to discuss the most common mistakes people make and the problems these mistakes cause.
Mistake #1: Checking Accounts Too Frequently
If you’re planning to cook a 20-pound turkey for Thanksgiving, you would never think of opening the oven every three minutes to check its progress. You understand that the process takes time and you’re okay with that. Goal-focused investing should be similar. Countless studies have shown that the more often you check your investment accounts, the worse investment performance you achieve. However, a common mistake for investors (particularly newer investors who are still learning the basics) is checking their accounts far more often than they should. Looking at your accounts too frequently exposes you to the day-to-day randomness of stock market returns, which coupled with the constant influx of financial media headlines, tends to create unnecessary panic. By checking your accounts less often, you’ll better insulate yourself from the daily noise of markets and improve your chances of investment success.
Mistake #2: Anchoring to a Specific Account Value
When the market is going up, it’s easy (and enjoyable) to watch your account values continue to grow. You expect this to happen over the long-term, which is why you invested in the first place. However, on a day-to-day, or even year-to-year, basis your account values don’t always move in one direction. When the market temporarily declines or experiences a bear market, your portfolio may take months or years to get back to its previous “high” point. During these periods, constantly comparing your portfolio to its highest value can cause you to feel like you aren’t making progress and can result in bad investment decisions, like selling at the wrong time or taking on too much risk to “catch up.” Instead, it’s better to focus on longer periods of time and compare your portfolio to where it started and where it needs to be for you to achieve your goals. You’ll often find that, even during these challenging periods for the market, you’re still on track to reach your goals, which brings peace of mind.
Mistake #3: Comparing Apples to Oranges
If you compared passing yards for NFL teams today versus those in 1930, you would see that today’s teams today have dramatically more yards per game. This is obviously because teams today are better at passing than they were in 1930, right? Nope. It’s because the forward pass wasn’t allowed until 1933. Context helps when comparing anything and, more often than not, when people look at their investments, they use the wrong benchmark and compare apples to oranges.
For example, someone who owned a globally diversified portfolio over the past decade but compared their performance to the S&P 500 would be severely disappointed, since the U.S. has outperformed international markets significantly over that time. However, their portfolio performed exactly how it should have based on their investment allocation, and during future periods when international stocks outperform U.S. stocks, they will feel much differently. Furthermore, people often forget that the only investment return that really matters is the one needed to reach their goals. There will always be some investment or investor that’s doing “better” than your portfolio, so when comparing performance, make sure you’re using the right benchmark.
Mistake #4: Falling Victim to Recency Bias
It’s human nature to pay more attention to things that happened recently and extrapolate them into the future. This also carries over to investing and helps explain why bubbles form as people become convinced that whatever investment performed best recently (S&P 500, Bitcoin, tech stocks in 1999, etc.) will continue to be the best performer. However, just because an investment has done well recently does not mean it will continue to do well in the future. In fact, the more that investors flock to a specific investment and bid up its price, the more likely that investment will subsequently underperform others. For example, the S&P 500 has been one of the best performing investments across the globe over the past 10 years, however, people forget about the previous 10 years when the S&P 500 experienced a “lost decade” and dramatically underperformed many other investments globally. If you only focus on what has done well recently, you’ll be much more likely to make the mistake of buying high and selling low, which isn’t a recipe for investment success.
So, What Should You Do?
Typically, these investment mistakes are made chronologically. You check your account for the 25th day in a row (mistake #1), you see that your investments are off the high point you became accustomed to (mistake #2), you see that one specific investment is doing better than your well-diversified portfolio as a whole (mistake #3), and you become convinced that since that one investment has been the best-performer it will continue to outperform (mistake #4). Because of this, you decide to sell all your other investments and put everything into the one that’s outperforming, only for things to reverse and that investment to then underperform. If you’re lucky, this only happens once before you learn your lesson.
Instead, start by building an initial investment portfolio that gives you the best chance of meeting your goals over your time period. This means having the right mix of stocks and bonds, diversifying your portfolio (owning thousands of stocks and bonds across the globe), and keeping your costs (expenses, taxes, trading costs) low. Once you have that investment allocation in place, then have the discipline to stay the course over time, only making adjustments to your investments if your goals change or you need to rebalance back to your initial allocation. When reviewing the performance of your portfolio, don’t check too frequently, and when you do, look at the performance within the context of the entire investment time period and the return that’s required to meet your goals. By following this approach, you can free yourself from the worry of what the market is doing today (or this month, or this year) and avoid some of the common mistakes that many investors make.
About MD Wealth Management: We are an Ann Arbor financial planner that specializes in providing financial planning for physicians and retirees. We are CERTIFIED FINANCIAL PLANNER™ professionals and fiduciary financial advisors who operate on a fee-only basis, which means we do not sell financial products or collect commissions. As an Ann Arbor financial advisor, we enjoy working with clients both locally and remotely.