In installment one and two six classic financial mistakes in executing a personal financial strategy were identified based on my observations of behavior over the last 40 plus years. Six of the topics include: Thinking Taxes are the Exclusive Answer, It Is Not a Good Time to Invest, Lack of Diversification, Ignoring Inflation, Not Understanding Risk, and Not Having a Comprehensive Plan can be found here and here.
Focusing on one factor in your financial strategy:
It is easy to come across an article or posting suggesting one should focus on a factor or element of investing in a financial strategy. The factor described could be value versus growth, large cap versus small cap, momentum or a variety of other factors that analysis have discovered in their work. It is not hard to find research that validates the phenomenon the factor isolates.
Factors imply you can get an “edge” on the market and obtain superior outcomes, The reality, however, is that while the factors indeed are based on facts, all factors go through extended periods of, sometimes dramatic, underperformance relative to the broad market. It takes extraordinary discipline to hold onto a strategy for 5 to 10 years of underperformance and not have a severe case of “I need to change something” likely just before the factor begins to work again. Multiple factors improve the probability of getting the desired result.
Maniacal focus on costs:
There is absolutely no question that understanding and paying the lowest reasonable fee for a service makes sense. Low costs can subject an investor to being deceived that there are no costs, when in fact there are significant and ongoing costs, to a product or service.
For example, on the surface annuities appear to not have any fees, yet, in many cases, they have multiple layers of fees, expenses and surrender charges not present in many other investment offerings. Some mutual funds also appear to be no-load but have 12b1 expenses to pay for marketing expenses. So, the investor gets to pay that expense? Amazing? Some investment offerings do have higher fees than others. It may be justifiable if the amount you net is more after fees and expenses. The burden of proof is on the fee.
Careful analysis of investment offerings is critical to making sure the investor is paying a low, reasonable cost.
Being a news junkie:
In today’s 24/7 news culture the proportion of bad news to good is way out of whack. It is important to either ignore most of it or at least filter out what is relevant versus merely attention-getting. Reacting emotionally to news reports can give an investor a false sense that they know something everyone else is ignoring.
Nothing could be further from the truth. It was broadcast to the world, right? Compensation is a major motivator. Compensation disclosure is vital in assessing the motives of virtually all human beings. The compensation for the news media is advertising. The more eyeballs the media has the higher the advertising costs and revenues. It is no surprise that getting out attention is critical to their business model. Education? Not so much! By the time most people see the news the market has already reacted. Acting on a news report has a high probability guaranteeing a loss of capital.
Summary:
It is easy, especially during calm times, to dismiss the strong built-in emotional pulls that we as human beings have. Exposure to uncertainty and uncertain events push us away from calm, rational thinkiing and a successful financial strategy. Daniel Kahneman, (mentioned in installment one of this series) described in his book “Thinking Fast and Slow” as System One and System Two thinking. Investors benefit greatly to understand these concepts. Know what the common traps are and how to recognize how these two ways of thinking are often in conflict. By recognizing when we are truly rational versus justifying a premise emotionally can be difficult. Conflict may indicate that having others on the planning team may be productive.