Once Upon a Time in the Stock Market...
As explored in a recent New York Times piece, “The Folklore of Finance: Beliefs That Contribute to Investors’ Failure,” a family’s financial goal is to achieve “true investment success.” But what does that mean, really? And why is this simple goal so challenging for so many investors in the stock market?
The article reports on a study that explored these very questions. The conclusion: “Suzanne Duncan, global head of research at State Street’s Center for Applied Research, and her team found that the way individual and professional investors made investment decisions was so skewed that achieving both high returns and long-term objectives was nearly impossible.”
In other words, in financial pursuit of fairy-tale endings in the stock market, we may find our worst, big, bad wolves when we look in the mirror. We tend to be led off-course from our happily ever after outcomes by fantastical “folklore” that we continue to tell ourselves long after the evidence has informed us otherwise.
Then, to add insult to injury, there are plenty of financial intermediaries out there who are willing to send you further astray by sustaining the same folklore fantasies.
The article points out two common sources of disconnect between fact and fiction, to which many investors fall prey:
Folklore #1: Believing Wily Forecasts Over Evidence-Based Logic
Deep down, most of us seem to know better than to believe in real-life crystal balls and other predictive powers. This includes the notion that there are financial gurus out there who can consistently achieve traditional “advisor alpha” by making clever, market-beating forecasts about future trends.
State Street’s study found that “only 53 percent of individuals say they believe alpha is attainable by skill.” And yet plenty of investors continue to buy into the largely discredited belief, with plenty of Wall Street representatives still happy to play the game along with them (and be paid royally for their role).
The article reports: “The financial industry continues to search for alpha as if it were a great white whale. The [State Street] study found that financial services firms spent 60 percent of their capital expenditures on resources to help generate short-term high performance.”
This brings us to our next point of disconnect …
Folklore #2: Reacting to the Recent Instead of Taking Your Time
The article continues: “Another disconnect revolves around time. Investors want to invest with a long time horizon yet react to short-term swings that derail the strategy.”
This one gets to the heart of investors’ greatest adversary as they seek to convey their treasures home through the wildlands of Wall Street. The evidence is clear that the best way for investors to build wealth is to keep their eyes focused firmly on the long-run factors they can control.
As such, portfolio management should include details such as tilting one’s portfolio toward or away from durable market risks and expected returns, managing those risks by remaining diversified across the global market, and controlling the costs involved. It should not include trying to chase or dodge the good or bad breaking financial, economic or global news reports.
In short, your investment interests are best served if you – and those advising you – ignore the folklore of fast financial footwork and instead adopt a long-term approach to accumulating wealth.
An advisor’s appropriate role? As Duncan says in the NYT article, “[Advisors] need to make sure that their clients are on track with their long-term goals – something that could be difficult to do if advisers can’t correct their own behavioral biases.”
Especially in this season for making fresh resolutions, there may be no better time to continue living by those words. Be it resolved!
Building wealth doesn't have to mean leaving your values at the door. From conscious capitalism to impact investing, you've got a lot of options for supporting your values through your investment strategies.