How Your Psychology Affects Your Investing
On its surface, investing for retirement seems to be all about getting the numbers right. Your timeline, your tax strategy, your portfolio allocation, and your income goals are all things that can be analyzed and decided on using math.
But there's another component to your investing that can have a significant impact on your results. And that's your psychology—how you think about yourself in relation to your investing.
In 2002, William Bernstein published The Four Pillars of Investing.1 This classic is recommended reading for serious investors and financial professionals alike. The four pillars in the title aren't the basic kinds of investments you should own (such as stocks, bonds, real estate, etc.), but rather the four concepts of investing that are foundational to success: (1) History (2) Theory (3) Business and (4) Psychology.
Twenty years later, when he revised the book for a second edition, Bernstein expanded the section on psychology, noting its outsized potential impact on investing returns. To illustrate this, he gives a real-life example of two contrasting investors. One was a high-profile hedge fund run by two Nobel Laureates. The other was the personal portfolio of a legal secretary named Sylvia. The hedge fund went belly-up after only four years. Sylvia, however, proved to be successful over a span of 67 years.
One big difference, Bernstein noted, was in how the two parties thought of themselves as investors. While the supposedly brilliant people at the hedge fund assumed they were entitled to large, short-term gains, the legal secretary assumed she would simply get rich slowly.
John Rekenthaler, vice president of research for Morningstar, summarizes it this way, "Speculators pursue high returns; investors pursue appropriate returns." He goes on to say that highly educated investors can be more susceptible to fallacies such as plausible sounding investment narratives, recency bias (giving too much weight to what just happened) and believing too strongly in one's own investment selection abilities.2
Of course, being informed about your investments is important. But that knowledge should be balanced by the realization that it does not make you above average in your ability to pick winners and losers consistently and predictably for the rest of your investing lifetime.
"The most dangerous delusion," states Bernstein, "comes not from how investors perceive the outside world, but instead from how they view themselves."
An educated investor knows that when saving for retirement, the most probable chance for success will come from pursuing appropriate gains, paired with appropriate risk, and executed through a diversified strategy.
Our advisors are happy to help you with a plan designed to achieve your retirement goals over the long-term, providing counsel and accountability along the way.
1. http://go.pardot.com/e/91522/s-of-investing-second-edition-/94qyvw/2219033357/h/IGAhSAz_j_qF6aKOSzahLqGOoc4l1Gf2s6p0Kr3f4fw
2. http://go.pardot.com/e/91522/llars-investing-second-edition/94qyvz/2219033357/h/IGAhSAz_j_qF6aKOSzahLqGOoc4l1Gf2s6p0Kr3f4fw
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