Why Managing Money Is So Hard
Written by David Fabian, October 10th, 2015
There are many casual observers in the investment world that probably think managing money is easy. All you have to do is come up with some sort of strategy that involves a definable technique or asset allocation structure. The next step is to align yourself with like-minded investors who favor your style above the other suitable variants. Then stick to the rules by implementing the strategy in their accounts and everyone is happy.
Sounds easy right?
The reality is far different from what you would expect. It’s not the strategy that is difficult to implement – it’s making sure that the investors who trust you with their hard earned nest egg don’t lose faith in it at the worst possible time.
This is primarily because you are dealing with a constantly evolving landscape that produces extreme emotional responses in unpredictable ways. Everything looks easy on paper because it’s not the real world.
Ever been standing on a dock before you venture out on an ocean voyage? You can map out your course perfectly using the most advanced tools available. The end result will likely be a straight line from A to B that looks reasonably easy to traverse. But at the end of the day, it’s simply a guide.
You can’t jump in a boat, point it towards a general direction, and expect that you are going to arrive exactly as planned. There is weather to account for, tides to correct, wave patterns to navigate, and human input that requires constant realignment. There is no such thing as a straight course in the open ocean.
The stock market has many of those same characteristics. That’s why it’s so easy to say that the S&P 500 Index has achieved double digit percentage gains over long time frames, but very few investors are able to match those returns. It’s because they make very real mistakes along the way that end up costing them significant sums of money, time, and opportunity.
Let me give you an example.
In August we experienced a three-day sell off in the SPDR S&P 500 ETF (SPY) of 8.99%. That’s a quick and scary event – particularly when one of the days led to a serious mispricing of many ETFs that created a further sense of uncertainty.
So on the last day of this decline, I got a phone call from a client who told me he wanted to go all to cash. He couldn’t take the volatility anymore and had a serious loss of faith in the market. He was virtually on the edge of having a panic attack on the phone with me. Mind you his account had experienced about a third of the decline of the stock market because of our conservative asset allocation.
Instead of feeding into that anxiety, I calmly talked about what had brought us to this point and what action steps would be preferable than going all to cash. I highlighted the probabilities of a bounce in the market and the quick resolution of the ETF pricing error being positives in light of all the negative media attention.
He agreed with every single point I made. Then still had me go 100% to cash anyways. That emotional decision cost him tens of thousands of dollars despite the rational part of his brain knowing it was a bad idea. The client has since left our firm and I wish him all the best.
The Bottom Line
The lesson in this instance is that every investment strategy and every investor is going to be put to the test at some point in time. The most successful investors are those that can rationalize the opportunities and risks without putting undo focus on a short-term emotional state.
Sometimes the best course of action during periods of stress is to remind yourself of the advantages of the advisor or strategy that you have chosen to begin with. Take a step back and realize that the market never goes up or down in a perfectly straight line.
There is nothing wrong with making subtle course corrections in the eye of a storm that will allow you to reduce your overall risk exposure or take advantage of new trends. However, making extreme shifts in your asset allocation with no plan for the future will likely produce sub-par results.
Looking for new ETF ideas? Check out our library of free special reports on growth and income investing.