The human brain is a remarkable thing.
Dr. Daniel Levitin, the New York Times best-selling author and neuroscientist (who also happens to be the guest speaker at a client event I’m hosting on October 15th), tells us that our brains have more neural connections than there are particles in the entire universe. And despite the dire warnings that science fiction writers have been giving us for decades, there’s still no super computer anywhere in the world that can even come close to the miracle that sits on top of our shoulders.
With so much going for us in the thinking department, it never ceases to amaze me how capable we still are of making really bad (and in retrospect, obviously incorrect) decisions when it comes to our investments.
Of course, we all know all the rules and maxims. Nuggets of irrefutable and uncontested wisdom like “buy low, sell high,” “ninety per cent of active strategies don’t even beat the market,” or “diversification is critical to long-term success.” Yet day after day, intelligent and informed investors continue to ignore even the most self-evident of these well-known homilies – getting ourselves into trouble in the process, and potentially even putting our future financial security at risk.
Let’s take that old chestnut about the importance of diversification as an example.
The reason diversification is so crucial is because the stock market is, by definition, a random and unpredictable environment. Since it can’t be reliably predicted, your odds of accurately picking the right stock, dumping all your dough into it and making a killing are slim to none (and Slim, as they say, just left the building). You might try it once or twice and get lucky. But the next time? Maybe not so much.
If you don’t believe it, just take a look at your favourite family of mutual funds. Most of the big banks offer 30, 40, even 100 different funds or more. If all the high-priced talent behind those funds really thought they could predict what was going to happen next, don’t you think they’d just sell one fund – the right one?
Nonetheless, when most people open up their investment statements, their immediate impulse is to ignore the principles of diversification and long-term growth they claim to believe in, and call their broker or advisor to tell them to do more of whatever happens to be working right now, and less of whatever isn’t. In other words, they want to dump the “losers” that are down that month, and put everything into gold, oil, U.S. stocks, or whatever else CNN is blaring about on that particular day.
By doing so, these investors aren’t only reducing their diversification and increasing their risk; they’re also violating yet another of those well-worn maxims that we all supposedly know to be true – namely, to buy low and sell high.
Thankfully, even though the markets might be essentially unpredictable, there are still a few habits or “routines” we can set up to trick ourselves into staying true to our principles, and keep ourselves from chasing after the latest hot tips or trends.
In my practice, for instance, we regularly advise our clients to purchase stocks, assets or geographic areas when they’re down – not when they’re “hot,” and everyone else is pushing prices higher in their rush to snap them up.
If Canadian stocks are high like they were in 2011 (because oil was going to $250 a barrel, don’t you know), then we sell some Canadian equities to buy U.S. stocks (which, at the time, were considered permanently compromised by the huge U.S. deficit, failing banking system, real estate collapse and so on).
Today, we’re selling U.S. stocks to buy Canadian assets. Not because Canadian stocks feel like a warm fuzzy blanket, but because they’re down and U.S. stocks are up. This lets us remove the temptation to scramble towards the latest stock- or sector-du-jour, and stay automatically diversified, regardless of what the markets (or TV analysts) may be up to. And we like diversification for one simple reason: because it works.
The tough part for most investors is staying true to their strategy of long-term diversification while voices are screaming at them from every direction to do the opposite of what they know in their heart of hearts works. If you find yourself wavering, just go back and take a look at how the markets were performing whenever the airwaves and Internet investment sites were at their most strident about buying gold, oil, high tech, emerging markets – you name it.
In retrospect, it’s easy to see now that those stocks were almost always at or near the top of their performance precisely when the voices endorsing them were at their loudest – meaning people who were unlucky enough to take their advice and invest in those “hot stocks” almost certainly lost money.
Jumping on the bandwagon of the latest high-flying stock, sector or asset class can feel great. After all, you’re officially joining the party, and those equities might even keep going up for a while. But as with any party, it’s the hangover that’s the unpleasant part – like when you look back a few months or years later with the benefit of hindsight, and ask yourself what you were thinking when you allowed your emotions to get the better of you, and poured all your hard-earned savings into oil-based investments when oil was at $140 a barrel.
For all their miraculous powers, our brains are hard-wired to gravitate toward what will bring us instant gratification right now – not what might reliably earn us much greater rewards over the long-term. The way around that dysfunctional wiring is to decide on a few clear, simple disciplines, and then stick to them through all of the market ups and downs (even if it’s occasionally through gritted teeth).
Decide what asset classes you’re going to have in your portfolio. Then re-balance back to those weights on a regular basis. That’s it. It’s not rocket science. But it can be surprisingly hard to do, because it generally means selling what’s “working” to buy what isn’t.
The good news is, if you can master it, your discipline will serve you well. And when the party next door inevitably crashes in on itself, you’ll be glad you caught an early ride home – or maybe decided not to go join in the fun at all.
Alan MacDonald an investment advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.
For more information please visit www.alanmacdonald.ca or email Alan at Alan.Macdonald@RichardsonGMP.com.
All material by Alan MacDonald, Investment Advisor at Richardson GMP Limited. The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP or its affiliates. Past performance is not indicative of future results.
Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.
