Originally published July 25, 2022
Is your portfolio too risky? What is ‘risk’? How do you measure it? These are all good questions and I have been pondering them since the beginning of the pandemic. In my opinion, most professionals do not understand what true risk is. They almost always talk about the volatility of the market. Without getting into statistical standard deviation, it’s how much the market moves up or down in a given time period, for example, a week, a month, or sometimes a year. Is this what we should really be worried about?
The Real Risk
To me, the real risk is anything that would stop me from achieving my financial goals. Most people want to achieve a certain standard of living and would like to retire comfortably within a certain time frame. So the real risks that affect this lovely outcome are things like not investing enough, not investing early enough, and not getting good returns. It’s definitely not the volatility of the market as most professionals would have you believe.
On the investing side, which is what this newsletter is all about, the real risk is not getting the returns that you need to achieve your goals. As I have said many times, small investors are notorious for murdering money through bad emotional decision-making. Their average long-term return is somewhere between 3-4%, which is a recipe for having to eat cat food in your old age. Or worse than cat food, having no choice but to continue working past retirement age. Now, some people like working, and that is awesome… good for you… unfortunately, it’s not me.
So there you have it. One of the most significant risks that the small investor is exposed to, is themselves. If the small investor cannot achieve market-like returns (~9%) in the long run, then they will likely have more difficulty achieving their financial goals within their expected timeframe. So what are the bad habits of most small investors? Here are the ones I see all the time.
Top 8 Bad Investor Habits
- Diversification Risk: Most investors wing it. They read something about the latest stock fad on the Internet and then buy a bunch of risky Zing Bang inc. There is no plan generally, so sector weightings are all over the place. There are so many ways to mess this up, for example, too many stocks, not enough stocks, missing sectors, too much weight in a sector, no or little international diversification. This unfortunately represents most investors! Does it include you?
- Emotional Trading Risk: Buying what is hot at high prices, then being scared out of the position when prices fall. I’ve seen lots of this recently.
- Asset Allocation Risk: This is controversial, but most people still believe that holding fixed income in a portfolio is safer and better than 100% stocks only. This is true in very few instances in the long run. In the very short run, it lowers a portfolio’s volatility and this is what financial advisors base their approach on. The reality is that people invest over decades so they should not care about volatility in the short run, especially if it’s going to cost them big time in the future. Would you pay $250,000, $500,000$, or more so that the portfolio squiggles are not as squiggly? That is basically what you are doing. The difference in end value can be astronomical. Fixed income generally underperforms and is only handy when you might be thinking of buying a yacht in the next year or two as it’s a cash-like substance.
- Trading Too Often Risk: I hate to admit it, but investing is supposed to be boring. The more active you are, the more likely you will underperform. I only make a handful of trades each year. For many months I do nothing. The high trading pattern is often linked to overconfidence and other behavior problems… talk to your vet.
- Missing the Big Picture Risk: So Mr. Market has sent a few of your positions to the moon and now they make up a big proportion of your wealth. You feel smart, but those positions are overpriced and you need to realize that you must rebalance the portfolio. Mr. Market can quickly take it all back.
- Large Speculative Positions Risk: What if most of your wealth is tied up in Buttcoin, the new crypto? You may love it and you are totally enthused by it, butt what if you are wrong and it loses 90% of its value overnight? Speculative stocks should never be more than 1-5% of your portfolio depending on your risk tolerance. I have struck out on one speculative position, but the effect overall was not terminal due to the small size of the position.
- Historically Weak Asset Class Risk: Gold spends most of its time losing to the market until it has a short but strong runup. Most people buy gold when it’s running up (buy high), then after it falls or does nothing for years, they get bored and sell (sell low). See the problem? I actually did this once… me bad.
- Not Measuring Performance: Every year I stress to people that they need to measure their performance against a benchmark. I use the S&P500, but you could use the TSX or a combination of appropriate indexes. This is the only way to know if you are achieving market-like returns and better yet if you are actually good at investing. Most people would rather not know because it causes emotional pain. Ironically, even though most small investors chronically underperform by huge amounts, they overwhelmingly tend to be repulsed by paying a Wealth Manager or the management fees of a market ETF even though their returns would be much higher. Humans are so complex.
I could go on. These are just a few examples of bad investor habits/mistakes that small investors make. True risk, as I mentioned is more about the things that negatively affect your financial goals. It should not be about guarding against volatility. The villain in investing is ourselves, so it should be about keeping your emotional brain in check. Market squiggles are normal and in the long run, they are (for the most part) not entirely relevant. They are part of the market dynamics and they help provide the equity return premium. So in a way, it’s a good thing when managed correctly.
A Final Word on the Market
Unfortunately, the market has gone up and the likeliness of it falling to -25% has decreased. If you recall, I have a great bear strategy that gets triggered once the market achieves this loss. I will have to make do with a normal, rising portfolio for now. Yes, it’s odd that I would prefer it to drop more. It’s my experience that it’s a lot easier to outperform when people are irrational and fearful. The market can change quickly so there is still a chance for a downturn. The world ends every 2-5 years so there will be more opportunities later if not now.
Happy investing.
Marc’s Monthly Moves
- Nada.
Marc’s Portfolio YTD Performance
- Portfolio return -12.75% (Including currency gains)
- Portfolio return -14.5% (without currency gains)
- S&P 500 return -16.68%
- TSX -10.55%
The portfolio overperformed the S&P 500 by 2.18%.
Money with Marc 