Investor habits: The good, the bad and the ugly
The good, the bad and the ugly is, of course, the title of the stylised 1966 western starring Clint Eastwood. It is also an apt way to describe common habits of investors.
No matter whether investment markets are rising or falling or somewhere in between, an investor's habits – good and bad – really matter.
The Journal of Portfolio Management has published an article, Bad habits and good practices, which opens with a disarmingly simple message for investors seeking sustained, long-term success: “Good investing results require both good investments and good investors”.
Its authors – professor with the University of Lausanne's department of finance Amit Goyal and investment fund managers/investment authors Anitti Ilmanen and David Kabiller – focus on three bad investment habits, providing contrasting good investment practices.
“We have spent our careers also battling these same bad habits in ourselves,” they write, “so our prospective is fully intended as commiseration and shared experience, not as lecturing.”
Bad habit one: Chasing multi-year returns
Goyal, Ilmanen and Kabiller say this is often cited as the “premier bad habit”. It involves abandoning long-term strategic investment practices to chase multi-year winners – meaning those that have outperformed in the last few years – while dumping multi-year underperformers.
This bad habit, which has been termed as “pro-cyclic” investing, can affect an investor's investment style, portfolio asset allocation, and their selections of individual investment assets and managed funds.
“Many investors understandably lack patience when facing years of underperformance, even if they are aware of the limited predictive ability in past performance and potentially high transition costs associated with hiring and firing,” they add.
“At worst, some investors may enter the market near its peak, despite exorbitant valuation levels, or capitulate near the bottom and miss the subsequent reversal.”
Many investors were willing to put up with a year of underperformance but “draw the line” at multi-year underperformance of, say, three to five years.
The countering good practice to this bad habit is to take a disciplined, long-term and appropriately-diversified approach with the aim of achieving well-defined investment goals. And regular counter-cyclical rebalancing of investors' asset allocations is fundamental to keeping their investing on track.
Bad habit two: Under-diversification
Goyal, Ilmanen and Kabiller say that many investors don't appreciate the benefits of proper diversification of asset classes and securities to spread their risks and opportunities.
Examples of under-diversification given in their paper include holding just a few stocks – in other, words, having excessively-concentrated portfolios – and having a home-bias with insufficient exposure to global markets.
They say a broad explanation is known as “narrow framing”. This is the tendency for investors to focus much of their attention on a single aspect investment or asset class rather than how it related to their overall portfolios.
Investors taking what could be described as a wider frame would tend to see a fall in the price of individual investments or an asset sector as just part of the expected movements within an appropriately-diversified portfolio. Indeed, well-diversified portfolios are designed with the intention of having some assets rising in value to counter other assets falling in value – rather than moving in lockstep.
Bad habit three: Seeking comfort while overlooking fundamentals
“Some investors seek comfort when selecting investments, whether individual securities or asset classes, instead of judging them purely on their risk/reward merits,” Goyal, Ilmanen and Kabiller say. An example of seeking comfort is to invest in the latest glamour stocks because of their image and their current popularity rather than on investment fundamentals.
And many comfort-seeking investors, for instance, pay too much for assets in their expectation for smoother, less-volatile returns.
A classic illustration of investors seeking comfort to their detriment involves following the investment herd by shifting to all-cash portfolios when the sharemarket experiences a sharp dip. And when share prices have already risen sharply, investors attempt to gain comfort in the crowd by following the herd back into the market.
A key take-away message for investors is that for every bad habit, as the authors of this paper write, there is good practice. Astute investors not only know what bad habits to avoid but develop strategies or practices to avoid them.
Robin Bowerman
12 December 2016
www.vanguardinvestments.com.au
Latest Newsletters
Hot Issues
- Aged care report goes to the heart of Australia’s tax debate
- Removed super no longer protected from creditors: court
- ATO investigating 16.5k SMSFs over valuation compliance
- The 2025 Financial Year Tax & Super Changes You Need to Know!
- Investment and economic outlook, March 2024
- The compounding benefits from reinvesting dividends
- Three things to consider when switching your super
- Oldest Buildings in the World.
- Illegal access nets $637 million
- Trustee decisions are at their own discretion: expert
- Regular reviews and safekeeping of documents vital: expert
- Latest stats back up research into SMSF longevity and returns: educator
- Investment and economic outlook, February 2024
- Planning financially for a career break
- Could your SMSF do with more diversification?
- Countries producing the most solar power by gigawatt hours
- Labor tweaks stage 3 tax cuts to make room for ‘middle Australia’
- Quarterly reporting regime means communication now paramount: expert
- Plan now to take advantage of 5-year carry forward rule: expert
- Why investors are firmly focused on interest rates
- Super literacy low for cash-strapped
- Four timeless principles for investing success
- Investment and economic outlook, January 2024
- Wheat Production by Country
- Time to start planning for stage 3 tax cuts: technical manager
- Millions of Australians lose by leaving savings in default MySuper funds
- Vanguard economic and market outlook for 2024: A return to sound money
- An investment year of ups and downs
- How to tame the market's skewness
- The Countries that Export the Most Wine in the World
- Tips for preparing for the best tax outcomes
Article archive
- October - December 2023
- July - September 2023
- April - June 2023
- January - March 2023
- October - December 2022
- July - September 2022
- April - June 2022
- January - March 2022
- October - December 2021
- July - September 2021
- April - June 2021
- January - March 2021
- October - December 2020
- July - September 2020
- April - June 2020
- January - March 2020
- October - December 2019
- July - September 2019
- April - June 2019
- January - March 2019
- October - December 2018
- July - September 2018
- April - June 2018
- January - March 2018
- October - December 2017
- July - September 2017
- April - June 2017
- January - March 2017
- October - December 2016
- July - September 2016
- April - June 2016
- January - March 2016
- October - December 2015
- July - September 2015
- April - June 2015
October - December 2016 archive
- Investor habits: The good, the bad and the ugly
- Keeping finances in the family
- The inter-generational financial squeeze
- Merry Christmas for 2016, a Happy New Year and a prosperous 2017.
- ATO set to clamp down on range of super issues
- SME retirement plans in jeopardy, research finds
- SMSFs show restraint in hot residential market
- Investment's building blocks - always worth reinforcing
- Warnings issued on traps with CGT transitional rules
- Meet SMSFs' early and late arrivals
- Beware, the ATO is on the hunt for lifestyle assets
- 'Brexit means Brexit' means what?
- SMSFs tipped to be hardest hit by pension changes
- SMSF assets hit record, but funds still hoarding cash
- Markets caution advised as economic bubbles loom
- Stretching retirement income
- Some financial terms explained
- Market Update – September 2016
- Checking in on our 2016 economic outlook - and looking ahead
- Making a fairer and more sustainable Superannuation System
- Going undercover
- ‘Winners and Losers’ from new super proposals