Does Investor Bias Make You Underperform the Market?
By Douglas Goldstein CFP® - helping olim handle their U.S. investments from Israel
A friend recently had a losing streak at the casino. Instead of walking away, he played more hands of blackjack. “I was determined to win,” he lamented. In fact, he was playing to recoup his losses.
He was a victim of investment biases subconsciously affecting his decision-making. Gambler’s Fallacy – the belief that after a streak of losses his luck would turn – duped him into doubling his losses. A recent study of Major League Baseball umpires showed how biases are at work in all forms of decision-making. In 1.5 million pitches, umpires were less likely to call a strike if the previous pitch was a strike.
Investor bias can lead you to make bad investing decisions. Biases are shortcuts in decision-making; you may, for example, increase your position in gold stocks because you have recently made a lot of money in gold, ignoring economic news that suggests gold prices are likely to drop. If you make a bet based on what just happened, you suffer from “Recency Bias,” like the umpire, who is more likely to call a ball after two strikes than one.
Passive and automated investment systems (such as dollar cost averaging) outperform active traders because they eliminate such human biases and judgements. Dollar cost averaging – making fixed investments on a regular schedule – improves returns by reducing volatility and human error.
Why do investors actively trade stocks?
The answer is overconfidence bias. Overconfident investors believe they have an edge over others; they are better stock pickers and market timers. The more humbling reality is that overconfident investors underperform the market. They are more likely to act on gut instinct than on research and analysis.
The major obstacle between you and better investment returns is often yourself. By making rational decisions and not letting your emotions dictate your trade orders, you may improve your investment results. To learn more about investor bias, read my blog, ProfilePerspectives.com/investor-bias
Douglas Goldstein, CFP®, is the director of Profile Investment Services, Ltd. www.profile-financial.com. He is a licensed financial professional both in the U.S. and Israel. Call (02) 624-2788 for a consultation about handling your U.S. investments from Israel. Securities offered through Portfolio Resources Group, Inc. Member FINRA, SIPC, MSRB, FSI. The opinions expressed are those of the author and not those of Portfolio Resources Group, Inc. or its affiliates. Neither PRG nor its affiliates give tax or legal advice.
Should You Follow Investment Trends or Bet against the Masses?
By Douglas Goldstein CFP® - helping olim handle their U.S. investments from Israel
Today, many “investment trend” websites are enticing online traders to join. Investors who follow the trend – also known as “momentum trading” – invest in stocks based on rising market prices rather than company fundamentals.
The strategy of following the investment trend performs best in a bull market. However, selling before the trend reverses is a skill that eludes most investors. When many investors buy the same stock, the market price can rise above the underlying value of the company. Eventually, as investors’ emotions stabilize, rationality may return, and prices fall into line with the fundamental value of the company (based on measures of revenues, earnings, etc.). Short-term momentum players who try to time market fluctuations seldom outperform buy-and-hold investors in the long term.
The trend can be a false friend
Herding behavior, whereby investors irrationally pile into a stock or sector, is behind most stock market bubbles. Two conditions for stock market bubbles are: new money inflows (which sustain the inflated price), and credit expansion (to generate the capital to invest). When credit conditions tighten, capital flows into the investment market slows and stocks start to decline.
When to bet against the masses
If a company’s fundamentals don’t support the stock price, it may be prudent to bet against the masses. Contrarians are often viewed as the mavericks of the markets. More often than not, their decision to go against the trend is based on thorough fundamental analysis.
If you base your investment decisions on sound fundamental security analysis, you may not always be a part of investment trends, but you will hopefully enjoy steadier and better long-term investment performance.
For more on the risks of following the trend, see my book review of Ben Bernanke’s book about the 2008 crash at Profile-Financial.com/bernanke
Douglas Goldstein, CFP®, is the director of Profile Investment Services, Ltd. www.profile-financial.com. He is a licensed financial professional both in the U.S. and Israel. Call (02) 624-2788 for a consultation about handling your U.S. investments from Israel. Securities offered through Portfolio Resources Group, Inc. Member FINRA, SIPC, MSRB, FSI. The opinions expressed are those of the author and not those of Portfolio Resources Group, Inc. or its affiliates. Neither PRG nor its affiliates give tax or legal advice.
Do You Look at the Risk-Reward Ratio of Your Stocks and Bonds?
By Douglas Goldstein CFP® - helping olim handle their U.S. investments from Israel
The risk-reward ratio is an attempt to quantify the amount of risk you need to take in order to get an anticipated return from any investment.
If you were to only consider past returns when deciding whether to invest in stocks or bonds, stocks would appear to be the clear winner. From 2007 to 2016, stocks had an average annual return of 9% versus about 5% for 10-year U.S. Treasury bonds.
If past returns are your only measurement of performance, then perhaps you should consider high-yield corporate bonds. This year, Harvard University’s endowment fund made its largest allocation to a high-yield corporate bond exchange traded fund (ETF), which had a one-year return (through March 2017) of 13.4%.
Risk vs return
Prudent investors know that past performance is not a guarantee of future returns, and instead of chasing last year’s returns they start by looking at their own risk profile. Indeed, some would say that Harvard marched farther out on the risk spectrum than a conservative education endowment should wander.
Fund managers always look at both the return and risk premium – the risk-adjusted return – of a stock or bond. The risk premium is one of the most important metrics in investing because it indicates how much money you may receive (the return) for the level of risk taken.
So, do stocks still make sense?
Stocks make a lot of sense on a risk-return basis. Looking over a long investment horizon, from 1967 to 2016, stocks returned over 11% on average compared to about 7% for 10-year U.S. Treasury bonds. Consider too, that stocks’ risk premium was 6.6% and the Treasuries’ 4.4%. By comparing the risk-return metrics, it appears as if investors are taking on added risk in exchange for incremental stock returns.
Diversifying an investment portfolio by adding bonds with a lower risk-return ratio may provide a superior risk-adjusted return. Find out why having a diversified portfolio matters at Profile-Financial.com/asset-allocation
Douglas Goldstein, CFP®, is the director of Profile Investment Services, Ltd. www.profile-financial.com. He is a licensed financial professional both in the U.S. and Israel. Call (02) 624-2788 for a consultation about handling your U.S. investments from Israel. Securities offered through Portfolio Resources Group, Inc. Member FINRA, SIPC, MSRB, FSI. The opinions expressed are those of the author and not those of Portfolio Resources Group, Inc. or its affiliates. Neither PRG nor its affiliates give tax or legal advice.
Can Optimism Increase Your Investment Returns?
By Douglas Goldstein CFP® - helping olim handle their U.S. investments from Israel
Are your investment returns determined by your worldview? Are people hardwired to be pessimists?
Millions of years ago, if an optimistic caveman dismissed a rustle in a bush as the wind blowing, our ancestor may have ended up as a tiger’s lunch. As a result of this early conditioning, the part of our brain called the amygdala scans everything we see and hear for negative news.
But according to Dr. Peter Diamandis, the founder of the coveted X Prize for Technology Innovation (and guest on The Goldstein On Gelt Show), this bias is more of a short circuit rather than an intelligent system design. He claims that in life and investing, it pays to be an optimist, as humans pay ten times more attention to negative news than positive news.
Why optimism outperforms
Technology is changing our lives for the better. A cursory list of human accomplishments over the past 100 years shows the future is indeed rosy – per capita income has more than tripled, extreme poverty has declined to less than 10% of the world, and human lifespan has doubled.
This is a time of abundance, also the name of Dr. Diamandis’ book, Abundance: The Future is Better Than You Think. The book’s most powerful message is that technology is “resource liberating,” as it makes once inaccessible resources available and abundant.
The future is optimistic investing
But how does all this optimism affect your investment portfolio? Dr. Diamandis does not mention specific companies but he does mention names, including Bill Gates and Ilan Musk – technologists behind inventions that are addressing scarcity and expanding resources, and the most successful companies in the world. If you believe the world is improving to be a better place, your optimism can find expression in choosing areas of the economy, and the corresponding stocks, in which to invest.
For more on optimistic investment opportunities turning science fiction into “science fact,” listen to our discussion at GoldsteinOnGelt.com/Diamandis
(The opinions expressed on The Goldstein on Gelt Show are those of the guest, and not necessarily my opinion or the opinion of Portfolio Resources Group, Inc.)
Douglas Goldstein, CFP®, is the director of Profile Investment Services, Ltd. www.profile-financial.com. He is a licensed financial professional both in the U.S. and Israel. Call (02) 624-2788 for a consultation about handling your U.S. investments from Israel. Securities offered through Portfolio Resources Group, Inc. Member FINRA, SIPC, MSRB, FSI. The opinions expressed are those of the author and not those of Portfolio Resources Group, Inc. or its affiliates. Neither PRG nor its affiliates give tax or legal advice.