If 2020 taught personal investors anything, it’s that managing your own investment portfolio is a dangerous game.
The typical DIY-investor relies upon news cycles, hunches, and emotion when deciding whether to be in or out of the market. The only thing predictable about this strategy is disappointment.
2020 was a volatile year, making it very easy to illustrate the collective mistakes of investors by charting flow into and out of Government Money funds over the course of the year:
S&P 500 Index Cumulative Total Return, Headlines, and Weekly Government Money Market Flows During 2020
The Biggest Mistake DIY-Investors Made in 2020
The news in 2020 was relentlessly negative: from the COVID-19 scare to business lockdowns, massive unemployment, and election uncertainty; yet the market ended the year up sharply. At various points throughout the year, personal investors collectively sold their equities and retreated to cash; most notably in March, right as the S&P 500 had bottomed at 34% below peak.
I have long understood that it is virtually impossible for an investor to act without emotion when their own account balances are at stake. Many financial advisors understand this danger and hire other advisors to manage their accounts. (Full disclosure: I do not hire an advisor for my accounts, but I have ice in my veins when it comes to investing).
Rather than trying to predict future values, why not try a rational approach? What might such an approach include?
- Understand why equity investing works so well. Equities (stocks) represent ownership in businesses. Businesses make money. Businesses that do not make money usually disappear quickly. The real return on stocks is approximated by the earnings of those businesses, and those earnings most often continue even when the selling value has depreciated. An investor who understands this does not sell their stocks in a downturn; they continue to own them because they are in it for the earnings, and the earnings continue.
- Buy low, sell high. It sounds so simple, doesn’t it? Yet an observer of the above chart will notice that investors (as a whole) did the exact opposite: They sold low and missed out on much of the subsequent appreciation.
- Rebalance. Few investors have 100% of their portfolio in stocks. It is just too wild a ride. At our firm, we more often see a mix of stocks and “fixed income” which consists of lower returning, safer bonds. The degree of exposure to stocks defines the level of risk in the portfolio. For example, an investor with 80% in stocks is expected to experience more volatility (risk) than an investor with 60% exposure to stocks. A rebalancing method involves setting an equity exposure and sticking with it. For example, an investor may decide that a 60% exposure to stocks is about right for the level of risk they are willing to assume. To keep that level of exposure, they would need to sell bonds and buy more stocks low, after a downturn, and sell some stocks high after they appreciate; the exact opposite of what most DIY-investors do! Perhaps the best feature of any rational method like this is that it eliminates emotional decision making.
As a fiduciary, I am not allowed to be biased, but I am (tongue firmly in cheek) biased in one respect: In order to avoid emotional investing decisions, I advise you to outsource the management of your investments to a qualified financial advisor.
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