Investing can be simple but it’s rarely easy. Our monkey brains are constantly playing tricks on us and taking mental shortcuts that can undermine even the best investing decisions.
There are well-known biases, like the pain of a loss outweighs the pleasure of an equal-sized gain by two to three times. Or the fact that we all think that we are above average.
Delve a little deeper into behavioural finance, and you’ll find there are a lot more tricks you need to be wary of.
Putting up barriers
One popular way of managing these pitfalls is to put up barriers that force you to behave a little bit better.
Sometimes these are inflicted upon us (nudge theory), which some people don’t mind but others find deeply creepy.
Or you can put them in place yourself. For example, here’s how Betterment’s Dan Egan manages his monthly cash flow so that he saves enough and avoids lifestyle creep ratcheting up his expenses.
The only investing plan most people need?
We could, for example, just invest in a simple 60/40 portfolio (60% shares and 40% bonds) and let the power of diversification do its thing as the decades unfold.
Arguably, the best advice for most people (95%+ of the population perhaps) would be to set up monthly contributions into just such a portfolio. You’d rebalance once a year, but otherwise leave it alone until you retire.
These days you can do the rebalancing automatically. You don’t even need to look at your portfolio value along the way!
Those of us who enjoy the game of investing, that is the challenge of beating the market and learning more about how the world works, need something more to keep us on the straight and narrow.
These are three techniques I’m using. They aren’t barriers as such, but ways I try and deflect my attention onto what really matters.
1. Focus on your whole portfolio
One thing I’ve found particularly helpful to consider my portfolio as a team of investments working together. Some are good at one thing, like capital growth, while others contribute more in the way of income and stability.
I can’t remember where I read it but if you find all your investments tend to move in the same direction and by the same extent, then it’s time to worry. You may not be as well diversified as you think!
I try to remember this when one or two of my investments go through a rough patch.
Murray International is a recent case in point for me. It has a great long-term record but struggled from 2013 to 2016 and in late 2017 and most of 2018. But it’s rallied strongly in the last month or so, much more so than most other global funds.
One of the main reasons I chose it in the first place was that it took a different approach from most other global funds, being less invested in the US and more in Asia Pacific and Latin America. Its manager, the impressively dour Bruce Stout, is often quoted railing against stock-market exuberance.
As long as this fund’s long-term performance is ok, I don’t mind it zigging while others are zagging.
The break-even disease
Down the years, I’ve found many investors are totally obsessed with their losers, particularly when it comes to individual stocks:
- whenever there’s a major price fall their instinct is to top up so that they can reduce their average cost.
- they ask “how can I expect to get back to break even from here?”
- many won’t even contemplate selling an investment at a loss, believing that to be a recognition of failure.
I’ve become much easier to live with now that I accept that losses are part and parcel of investing. You don’t need every position you have to be a profitable one. Which is lucky, because many of them won’t be.
It’s the return of your whole portfolio that really matters, and that’s where your focus should be.
Although I track the overall performance of my portfolio, I don’t monitor how well each individual position is performing (other than for capital gains tax purposes for those held outside an ISA or SIPP).
Of course, I’ve still got a rough idea of what’s doing well or what seems to be lagging behind. But when it comes to any decision to sell, leave alone, or buy more, I try to focus on the current position size, not the price I paid or what it peaked at.
2. Focus on the income produced
I have to confess that I check my portfolio’s value far too often. Often several times a day.
One thing I’ve found very helpful is to put the annual income it produces right next to my portfolio’s value.
I want to build that income number to fund my living expenses, so it makes sense to give it equal prominence.
Another advantage is that this number doesn’t move very much. I have some dividends denominated in dollars and euros, so it does move a little as exchange rates zip around. But, on the whole, it remains reassuringly stable from day to day.
In most cases, I’ll use the last year’s dividend. When a company announces a dividend target or increases the rate of its quarterly payments, I use that instead. This makes it an estimate for the forthcoming year’s income, but hopefully a slightly conservative one.
Another benefit is that you should get to see the income figure steadily rise over the course of the year as you buy new shares or a dividend increase is announced.
That’s soothing for the soul… and the wallet.
The high-yield trap
The main danger, or at least the main one that I perceive right now, is that it could lure me into preferring high-income investments at the expense of low-income ones. There should be a place for both in your portfolio I think.
Therefore, I track my portfolio’s overall yield to make sure I’m not getting too income-obsessed.
Currently, the overall yield in my main portfolio is 3.1% with the individual trusts varying from 0% (Smithson) to 8.2% (Baronsmead Venture Trust).
Now, I’ve only been using this approach during a period of rising dividends. In fact, I don’t think I have had to enter a dividend decrease since I started doing it. It remains to be seen quite how I’ll feel should the income number drop by a significant amount.
Investment trusts have a good record of maintaining their dividends over time, so this may not be an issue. But it’s still something I need to be prepared for.
3. Focus on how much you can put in
As I check my portfolio far too much, I try to put that time to some good use.
Right below my portfolio value is a little list of the amounts I plan to invest over the course of the next year or so.
I have a calendar of forthcoming dividend payments so I know roughly how much I’ll have available each quarter. And I include any planned ISA or pension contributions. Any investments I plan to sell to use up my annual capital gains allowance go in there as well.
As I don’t chop and change my investments too much, this doesn’t take too much maintenance. But looking at this list on a regular basis helps me focus on one of the main things I can control about my investments — how much I can put in.
As with the income figure, I don’t want to see the amount I plan to invest go down. So I think this helps me to budget properly and free up more money to invest.
I don’t tend to decide exactly what I am investing in that much ahead of time. I pencil in a few options for the next dividend reinvestment, based upon my current portfolio weightings and how I’d like to tweak them. But that’s pretty much it.
Anyway, must dash. Portfolios don’t look at themselves you know!
Note that I may own some of the investment trusts mentioned in this article. You can see my current holdings on my portfolio page. Nothing in this article should be regarded as a buy or sell recommendation as this site is not authorised to give financial advice and I'm just a person writing a blog. Always do your own research!
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