When investing many people hear their friends or colleagues talking about their investing successes. In many cases this involves investing in portfolios with a higher risk than is appropriate for them. The lure of the higher return is compelling to most of us.
When investors compare their returns to anyone else they ignore the level of risk each is taking. If you are investing rather than speculating or gambling you need to know the expected return and the expected volatility (risk) of your portfolio.
Psychologists Kahneman and Tversky showed that more people would prefer to make $70,000 per year when others were making $60,000 than to make $80,000, when others were making $90,000. There will always be “others” with more assets, money, or larger portfolios. We are doomed to disappointment because comparison destroys the joy of having and using what we already have. Most people would agree to make or have less as long as others were even poorer. Resist the impulse to compare yourself to your “neighbors”.
This includes comparing your retirement portfolio or 401(k) account balance to your colleagues. In some instances you may be better in others worse. The goal of your investments is to attain your long term goal. This would include a strategy and savings discipline.
Developing a prudent strategy and remaining disciplined to it are very difficult, however in the long term will lead to success. No one can predict what asset class or sector will outperform in the future with any degree of certainty.
Warren Buffet has one strategy which he remain disciplined to. This is the primary reason for his success.
As an example of portfolio envy. Imagine that it’s January 2000 and you are looking at your yearend statement. If you were invested in U.S. Large Cap Growth you huge returns. Now imagine that someone introduces you to a famous money manager who lost 15% in this same period.
What would you say about investing with this manager? Of course, your answer would be ‘no’. You would have said are you out of your mind? Your natural instincts would be to load up on U.S. Large Cap stock funds.
Well that money manager was Warren Buffet. During the subsequent ‘tech’ crash the U.S. Large Cap stock funds were devastated and Warren Buffet thrived.
Remember past performance is no indication of future results.
You are speculating if you stock pick, market time or base your investing decisions on track record performance. Keep in mind speculating is ok, but not with your retirement funds.
To succeed in investing you should
own equities…globally diversify….rebalance.
What does all have to do with your portfolio? Well before you compare results make sure you’re comparing apples to apples. Be certain you are comparing portfolios with similar levels of risk.
An aggressive portfolio will look great in up markets but in down markets will be devastating. This is ok if you are young and have time on your side.
However, if you are at or near retirement. You need to control risk and limit volatility.
