The Space Between Glum And Glee

“As a country, we go from glum to glee and glum to glee over and over again,” said investment strategist James Paulsen in a November 19 Bloomberg article assessing current market valuations and economic indicators. So which is it now? Post-election, at least we now know a little more about where we stand politically. But pre-Fiscal Cliff, our financial future remains as murky as ever.

Most investors assume that the greatest challenge they face is predicting (or hiring someone who can predict) when the greater financial tides are about to turn, so they can successfully trade just ahead of the news. In reality, I believe that investors are experiencing a sleight of hand when they try to react to current events, be they gleeful or glum. The trick is to instead keep your eyes on the investment factors you can realistically expect to control:

Controlled Investing: Proposition #1

By steadfastly maintaining your low-cost, globally diversified portfolio according to your personal goals and risk tolerance, you can most effectively capture expected market growth over time, in relation to the amount of market risk you are willing to tolerate.

Controlled Investing: Proposition #2

Your personal investment behaviors are expected to have an enormous impact on your net returns. And unlike outside influences (such as fiscal cliffs or election outcomes), you have total control over what those behaviors will be. Why not focus your investment energy on making those behaviors count?

This is easily enough said, but adhering to a controlled investment strategy is admittedly difficult amidst the ever-distracting flash of current events. If it makes you feel any better, the challenge is certainly nothing new. Just prior to the November elections, financial columnist Jason Zweig offered us a fascinating history lesson in his Wall Street Journal article, “Can You Trust Your Stockjobber?” He directed us to newly published research on some of the earliest days of stock portfolio investing, indicating that early investors exhibited the following traits from 1690–1730:

• They were under-diversified; 83 percent of them owned only a single stock.
• They chased performance; when prices went up, so did the number of trades.
• They underperformed as individuals what the market as a whole delivered.

With the exception of the single-stock portfolios (per Zweig’s article, the average is nowthree stocks instead of just one), these bullet points have remained stubbornly consistent across centuries of investor performance.

The part I find most frustrating is that these behaviors need no longer apply, if they ever did. With so many low-cost investment solutions now available to us, each of us has ample opportunity to widely diversify our holdings, avoid chasing past returns and expect to capture market returns, net of readily controlled costs.

Zweig concludes: “In order to be a superior investor, you have to combat the crazy ideas of those around you and, above all, fight the hobgoblins in your own head. That was true in 1720. It is at least as true in 2012 as it was then.”

I couldn’t agree with him more.