A few months ago, I came across an article1 in The Wall Street Journal that made me think twice about two important aspects of my life: my clients’ investments and my golf game. The article explained that most golfers overestimate their abilities when they use specialized clubs designed to optimize distance and control.
According to researchers at Arccos Golf, poor club selection was the reason 40% of approach shots landed short of the green. Why? Golfers chose their club based on how far the ball would travel if they hit their best shot.
Golfers aren’t the only ones who overestimate their abilities—investors allow inflated performance expectations to influence their behavior too. According to the Journal of Economic Perspectives,2 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.
Don’t count on ideal conditions
Thanks to your smartphone, you can access the latest economic news and fund performance figures in seconds. And thanks to strong markets, you may be feeling confident about your investing skills. But beware: It’s easy to succumb to impulse and change your investing strategy amid a perfect storm of information and overconfidence.
Feeling confident about your investing skills and making well-informed decisions are admirable qualities. The problem is that market conditions are rarely ideal. Investing, like golfing, involves factors that are outside your control—factors that can drastically affect your performance. It’s much harder to lower your handicap when conditions aren’t ideal. And the truth is, most times they aren’t.
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.3
Author Chuck Swindoll once said, “Life is 10% what happens to me and 90% how I react to it.” The way I see it, investment success isn’t much different. I can’t necessarily prove it, but I hypothesize that investment success is 10% market performance and 90% how you react to it. You can’t control how the market performs, but you can control how you respond.
So what can you do? Tune out the noise and focus on your long-term strategy. This evergreen advice is applicable in bull and bear markets alike.
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 temps you to flee to cash, consider the longer-term implications, which include missing a potential market rebound and losing future growth opportunities.
Do the right thing
Trust your asset allocation to set up every shot for you, eliminating the possibility that any one swing (or trade) can make or break your game.
Choose a mix of stocks, bonds, and cash that complements your goals, time frame, and risk tolerance. The objective is to find a mix that will help you reach your long-term goals and let you sleep at night. Then make your peace with the fact that all investing involves risk.
There are several “wrong” reasons to buy or sell—reacting to market news, jumping on the bandwagon of the latest trend, and believing that you can time the market top the list. The “right” reasons to make a change to your portfolio include rebalancing and accommodating major life changes, such as the birth of a child or the decision to retire.
Staying the course isn’t as flashy as aggressively going for the green in 2 shots on a long par 5. Dedication to long-term success is a mental game that requires time, energy, and commitment. You have to recognize (and challenge) your own biases and avoid investments that demand ideal conditions. A strong stance is crucial—not only when you’re lining up your next shot, but every day.
1 Wall Street Journal, May 12, 2017. Why golfers overestimate their ability.
2 Journal of Economic Perspectives: Volume 29, Number 4, Fall 2015. Overconfident investors, predictable returns, and excessive trading.
3 Source: openfolio.com/data.
- All investing is subject to risk, including the possible loss of the money you invest.
- There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
- Diversification does not ensure a profit or protect against a loss.