Why successful investors avoid knee-jerk reactions

-- | 19/03/2019

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For millions of people around the world, the season of Lent represents a period of self-denial as we look ahead to a future feast. Such periods are important because people tend to focus on the here-and-now and not the longer-term consequences of our actions. This is especially relevant for investors as the impact of our decisions are typically felt over years and decades rather than just days and weeks. It therefore feels like a good time for investors to think about our habits and behaviours and consider some changes to improve returns over the long term.

The first discipline is to avoid looking at your portfolio too often. While it is natural to want to know how your portfolio is doing, frequent checking of performance can have a negative impact on your returns as we tend to over-react to small movements in the price of our investments. This, in turn, can lead to more frequent trading which not only increases the costs of the portfolio but also increase the probability of us making mistakes. It takes self-discipline to avoid looking at your portfolio, but it is worth remembering that many of the best investors tend to have long holdings periods and make few changes.

The second discipline is to avoid making short-term forecasts as these tend to lead to poor decisions. Often, we are not even aware that we are making such forecasts as they are such a normal part of everyday life. A great example of this problem is Brexit. The outcome of Brexit remains unknowable to most of us, but we all have an expectation of what will happen at the end of March. Such views can easily impact the way we invest. As humans we tend to be over-confident in our views and hence these forecasts can lead to poor outcomes. But forecasting can be a hard habit to break and so it is helpful to have something else to focus on. At Morningstar, we seek assets that are attractively valued and are therefore likely to deliver higher than usual returns over the long term. This approach leads us to place less emphasis on the short term and reduces our susceptibility to forecasts.

Like all disciplines, these changes in behaviour can be challenging to implement as they typically form part of our daily habits but critical self-reflection is an essential element of investor success and a key focus for the team here at Morningstar. Denying yourself is not easy but the rewards are worthwhile.

This report appeared on www.morningstar.com.au 2021 Morningstar Australasia Pty Limited

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