YOUR INVESTMENTS: Are you an overconfident investor?

Why was 2017 a good year for financial markets.

money (photo credit: REUTERS)
(photo credit: REUTERS)
2017 turned out to be a good year for financial markets.
Double-digit gains were the norm. It’s much easier to make money when everything is appreciating. The temptation for investors is to start taking more risk than they are able to handle. This week I have received many phone calls from clients who all of the sudden want to sell “boring” assets in their portfolios and start moving into more speculative individual stocks.
Whether this makes sense is based on each individual investor’s risk profile. But the danger of this approach is that investors are becoming too confident in their investing abilities.
When investors rely on their ‘skills’
Vanguard senior financial adviser Tony Giordano quotes a piece that appeared in the Journal of Economic Perspectives in 2015, titled “Overconfident investors, predictable returns, and excessive trading.” The report said: “Investors attribute strong portfolio performance and high returns to their skills, which leads to self-assurance. When the same investors experience poor performance and low returns, they attribute it to bad luck.
The result: persistent overconfidence.”
Persistent overconfidence can lead to poor investment decisions.
Call it greed or whatever, but I’ve seen too many times where after a good year in the market, some investors lose sight of their financial goals and needs and decide to chase after higher and higher returns. You all know what eventually happens, and it’s not pretty.
Giordano continues: “Recent data shows that when investors rely on their ‘skills’ to beat the market, they usually come up short. The average 2016 return among the 70,000 investors who tracked their portfolios on the Openfolio social network lagged S&P 500 total returns by more than seven percentage points.” Ouch!
Stay strong and avoid the temptation Resist the temptation.
Giordano sums it up: “If strong market performance makes you headstrong with the possibility of quick returns, avoid the temptation to go after investments that will expose you to more risk than you’d feel comfortable with under ordinary circumstances. On the flip side, if poor market performance tempts you to flee to cash, consider the longer-term implications, which include missing a potential market rebound and losing future growth opportunities.”
Asset allocation in your portfolio
I have said it a thousand times, but it bears repeating: Creating your asset allocation, or the mix of stocks, bonds and cash in your portfolio, is the single most important task that an investor has to face. Many studies have shown that the proportion of stocks, bonds and cash held in a portfolio has a greater effect on its returns and volatility than the individual investments that are chosen. That is why after assessing one’s investment goals, it’s of the utmost importance to create an allocation that can help you achieve the aforementioned goals.
Especially after the market run-up of the last few years, it’s important to reassess your portfolio. Much has changed in the world over the last year. Investors should take the time to make sure that their portfolios are well positioned for current conditions.
In time periods when stock returns are much higher, many investors can find themselves with portfolios much more heavily tilted toward stocks then when they started out.
One of the most overlooked aspects in long-term investing is the need to rebalance a portfolio. Rebalancing is important for two main reasons. First of all, it keeps your portfolio in tune with your long-term goals. Secondly, it keeps your asset allocation in line with your risk level.
What’s the upshot of all of this? Stay the course that you started out with. Part of your financial plan took into account good years in the market. Take the money and say thanks. But don’t get overconfident and start getting more and more aggressive and end up making costly mistakes. If you follow your asset allocation and rebalance your portfolio, you will be able to achieve your financial goals.
The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc., or its affiliates Aaron Katsman is a licensed financial professional in Israel and the United States who helps people with US investment accounts. He is the author of the book Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing.