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Many entities — not just investment firms, but also magazines, broadcast media outlets, newsletter publishers and the financial media in general — have a vested interest in investors becoming hooked on investment noise (or what Jane Bryant Quinn called “investment porn”).
Why? Because greater traffic and attention helps drive their profits. The interests of the financial media are not necessarily aligned with the best interests of investors. The winning strategy for them is highly likely to be the losing strategy for you. What’s more, there are far better and more important things to do with your time.
Below, we’ll discuss five areas in which paying attention to the noise can cause investors to stray from even a well-thought out investment plan.
Paying attention to the often urgent noise of the moment, however, can lead investors to abandon their diversified strategy and chase the latest mania, be it social media, tech, biotech, bowling alleys (yes, there was a bowling alley bubble) or tulip bulbs. Investors also often make the mistake of believing that diversification works “by the numbers". Owning 10 different mutual funds isn’t effective diversification if they all own the same group of U.S. large-cap growth stocks; that type of diversification only reduces single-stock risk.
The IPS should include both specific asset allocations and a rebalancing table. Most importantly, it should be signed by all the parties involved as a reminder that they have carefully thought out the plan and made a commitment to maintain the discipline required to stay the course. The plan should only be changed if the investment horizon shortens and/or risk tolerances and the need to take risk is altered due to life events (such as death, divorce, inheritance or job loss). Market noise causes investors to stray from their plan as they chase hot sectors, search for the next Google, or panic in down markets.
Unfortunately, noise causes investors to think short term. In fact, the “long term” for many investors has become a month, week or even a day. Noise causes investors to become traders. During such tempting times investors would be wise to remember Warren Buffet’s observation in the 1996 Berkshire Hathaway Annual Report: “Inactivity strikes us as intelligent behavior.”
However, the returns investors actually earn from their investments are likely to be far more dependent on the discipline they maintain in adhering to their plan than on the specific allocation. The evidence demonstrates that paying attention to all the noise causes investors to lose discipline, panicking in bear markets and getting greedy in bull markets.
The discipline to stay the course is likely to prove to be at least as important a determinant of investor returns as both the asset allocation decision and the choice of actively managed funds versus passively managed ones (such as index funds). In fact, I’d even go so far as to say that if someone uses a financial advisor, and the advisor does nothing but keep their client disciplined in adhering to their plan, the advisor will likely have earned their fee several times over.
A quarterly review is also a good time to check for any tax-loss harvesting opportunities. Asset allocation changes should only be made because rebalancing tolerance levels have been exceeded, or a life event has occurred that impacts your ability, willingness or need to take market risk.
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