This post is a preview of WorthPointe’s e-book Evidence-Based Investing: Separating Fact From Fiction, written by Certified Financial Planner™ Scott O’Brien. In Evidence-Based Investing, Scott discusses the myths and misinformation that most often slow or halt our financial goals. Get your complimentary copy of Evidence-Based Investing here.
What is a good strategy?
Start by creating an Investment Policy Statement (IPS), which outlines your investment allocation strategy and how far you’ll let your portfolio deviate from your target allocation.
Meir Statman, behavioral professor at Santa Clara University, said, “When at high speed, the car in front of us stops quickly, we instinctively hit the brake pedal hard and lock ’em up. It doesn’t matter that all the studies show that when the brakes lock, we lose control.”
Statman suggests that just as drivers need anti-lock brakes, investors need anti-lock brakes for their portfolios, too.
This is where a well-written IPS comes in. Humans instinctively react to investment situations in ways that might have saved our lives fighting on distant battlefields long ago. But today, those reactions are counter-productive — just like locking up your brakes.
When the market drops, our instinctive fear–flight response is so strong that even the most rational investors find themselves caving in to their own fear. And market tops often happen soon after the staunchest of bears throws in the towel and turns bullish.
In The Odyssey, Sirens lured ships to their island with their sweet songs and then killed the sailors. As his ship neared the Sirens’ island, Odysseus, aware of the Sirens’ power and his own inability to resist their songs, ordered his sailors to put wax in their ears and tie him to the mast (note that he doesn’t put wax in his own ears).
As his ship passes the island, Odysseus endures the agony of the Sirens’ songs and orders his sailors to change course toward the island. But of course, the sailors don’t hear him because of their earplugs. The ship stays on course and they all live.
Like Odysseus, investors need a mechanism to stay on course: their IPS and perhaps their advisor. When the declines come, as they inevitably do, and your stomach starts to ache in pain, your IPS will help you use your head instead of your stomach or emotions to make decisions.
Read the rest in Evidence-Based Investing. Get Your Complete Copy of the Book Now.
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