This month we are talking about applying the principles and practices of smart investing to our financial endeavors. This week we will talk about the principles of faith, patience, and discipline and how applying these principles can help you potentially avoid emotional investing blunders.
These principles can help fill what we call the “behavior gap.” The behavior gap is when you have an investing tantrum when you should have just taken a time out. Another way of saying this is - you do the wrong thing at the wrong time. This term came about because of an older study done by Dalbar using analytics and data from Lipper and the Investment Company Institute to show that investors can do themselves more harm than they realize. They analyzed the S&P 500 between 1992 and 2012, which showed that the index returned 8.21% for the period, while the average investor earned about half of that, 4.25%. The explanation for the difference is the “behavior gap.” Let’s look at the principles used to avoid the behavior gap.
The first is faith or faith in the future. A historical view of the markets shows that after each of the bear markets, downturns, or corrections, longer periods of growth take place. Things like technological advancement, increased longevity, and business expansion come with the future. These are all good things that have typically pushed markets higher. We don’t want to miss opportunities by being out of the market for the upturn.
Periods of volatility are just a bump in the road of our long-term investment approach. When markets recover from volatile periods, they are not only followed by growth periods, they tend to reach new heights as time progresses. Having faith is critical for retirement planning, so be a smart investor and don’t fear the future.
What about patience? Fear of missing out can cause investors to “feel” like they aren’t doing enough with their investments; maybe they should make a change or take part in an investing trend. When this happens, an investor will often make changes to their portfolio that are not in line with their financial plan. If you get this bug and get it often, you start trading investments in your portfolio, and frequent trading is not good for overall performance. It’s best to ignore “what’s working now” (fads) and stay focused on what has historically worked in the long term, i.e., what you have probably had in your portfolio that is chugging along just fine.
And last, but certainly not least, is discipline. Discipline is possibly the hardest for us humans to master. Put a game on and shove some wings in front of me, and I’ll forget who and where I am for a while. But we can’t afford to lose discipline and get distracted when investing; that can be a costly mistake, and here’s why. When we lose discipline, we lose sight of our goals; we see something shiny and rush toward it like an oasis in the desert when it ends up being just another flash in the pan; think Game Stop or any other recent phenomena. There are so many things that can distract us from our investment plans, goals, and strategies - not just the latest investing fad. I could make a long list of distractions; keeping our eye on the long-term prize is the key to better outcomes.
Having patience applies to possessing the capability to hold yourself back from doing something wrong with your money and discipline is the corresponding action. Simply put, the difference between patience and discipline is your ability to do the right thing even when it feels wrong. So you have the capability with strong levels of patience, and you stay disciplined by actively choosing to do the right thing. A good advisor who understands the critical importance of also being a behavior coach can be really helpful with this.
Next week we will get into the first of the three practices that align with these principles, asset allocation.
Until next time…
One last thought, I believe an educated investor is an empowered investor. If you like what you’ve read and think your friends and family can benefit al, please share.