Striving for simplicity
Investing is simple, but not easy.—Warren Buffett
Warren Buffett once described investing as ‘simply, but not easy’. It’s a famous quote on how the premise and action of investing is simple, but it can often be tripped up by our psychology and emotions.
A classic example of this is the simple choice of:
- Buy high, sell low
- Buy low, sell high
If you were asked to choose between the two actions, it seems like an easy choice to make. Of course, we would choose the second option over the first. Unfortunately, we often do not make this choice and that is because investing isn’t natural.
If other people like an investment, the price will go up as demand for the investment increases. If the price goes up, with all other things being equal, you’re buying high. We like the feeling we get when we see green in our portfolio, and we tend to invest at these times when markets are rising because we don’t want to miss out,
The red of your portfolio forces to feel the exact opposite—pulling away from that feeling feels natural and that’s where we see investors withdrawing at the bottom of the market. Withdrawing, or even just refusing to invest when markets are undervalued goes means that we’re missing out on the opportunity of investing in cheap stocks (all things being equal).
So ultimately, investing isn’t natural. One of the largest risks to investment performance is our own behaviour.
Morningstar has conducted a study called ‘mind the gap’ since 2010, quantifying emotionally driven investor behaviour. Big pivot years for the markets lead to the worst timing for investors. What this means is that investors sell after a bear market and buy after a bull market—even though one of the most well known investing adages is buy low, sell high. We all know this, but in practice it’s very different when emotions come into play. This played out during the GFC for US investors, where the gap widened even further—we saw a lot of panic selling at the bottom, missing out on a dramatic rebound.
The key to any strategy is a foundational understanding of what your goals are and what you need to get there. Decisions regarding your investments must be made in line with these factors, instead of emotional decisions driven by market noise. Ensure that any changes to your portfolio positioning is part of your investment strategy, and in line with the risk/return balance you need to achieve your financial goals, instead of a reaction to the market.
To learn more about the goal setting process read The Morningstar Guide to Portfolio Construction or watch a replay of our Investing Bootcamp Goals Based Portfolio Construction webinar.