My friend Bob Seawright has a great piece up on ThinkAdvisor titled “How Advisors Can Make Better Decisions.” It is a great read and explores how our behavioral biases lead us to make terrible decisions and how we can combat that.
But (in my opinion) we are missing one step: first, make fewer decisions. Investors and advisors are swarmed with investment decisions to be made on a regular basis. We have:
- 5,000 listed publicly traded US stocks
- Tens of thousands of global public stocks
- 7,000+ US listed mutual funds
- 1,000+ US Exchange-traded funds (ETFs)
- $80 Trillion in global bonds;
- Countless “alternative” investments including private equity, hedge funds, commodity futures, private real estate, etc.
As investors trying to navigate this entire marketplace, we will easily be overwhelmed by the sheer volume of decisions we face. Before we start making good decisions, we need to learn to make fewer decisions. We have to reduce the chances we will have to make mistakes. We need to reduce our opportunity set, and do so vigorously. We need to say “no” to a great many things in the investment world. If investment opportunities were countries on a map, we need to decide here and now where we’re just not willing to go. We need to decide which products we are using, which asset allocation strategies we are using and what metrics drive our decisions. And that starts with a well developed investment policy.
Whether you are a DIY’er, working with an advisor or an investment professional you must have an investment policy statement (IPS). The beauty of a well written IPS is that it is making many decisions for us! A good IPS will clearly spell out decisions around asset allocation (strategic, dynamic, tactical), rebalancing, tax policy and which products we are using in portfolios. It will establish, in advance, whether we are scouring the universe of 7,000 mutual funds for a star manager or utilizing cheap index funds and ETFs for exposure. It will remind us that we’ve already decided how much of an allocation to have to large cap US stocks or emerging markets. It will tell us that we’ve already decided if and how we are going to react to that news in Europe or the current CAPE ratio or the fact that the S&P 500 broke its 50-day moving average. The IPS will let us know at what time to rebalance our portfolio so we aren’t trying to make that decision in the moment.
Trying to make these kinds of investment decisions is a lot like dealing with a crying baby at 3AM (which, as it turns out, I know something about). My wife and I quickly figured out that there was just no way we were going to make a good parenting decision at 3AM while one of us has been holding a screaming 10 week old for 40 minutes. So we learned to make fewer decisions in the middle of the night and it kept us from making bad decisions in the middle of the night. The more we could plan in advance, the better our behavior was and the better decisions we made.
So please, make better decisions. Be more aware of your own behavioral biases and learn to create an environment to control them. But first, focus on making fewer decisions. Doing so will greatly reduce the number of mistakes you are making, the key to winning this losers’ game.