Investing for Survival

Investing for Survival---Behavioral Biases from Capital Spectator

Running With The Crowd. We’ve all been there. When everyone’s bullish, it’s hard to pare back weights in asset classes that have done well. On the flip side, it’s mentally challenging to tilt the asset allocation into poorly performing assets. The trouble here is that some of this inclination is grounded in common sense. The markets aren’t perfectly efficient, but they’re not anywhere near absolutely inefficient either. In turn, that means that it’s unlikely that you’re going to find a hugely positive expected return for a given asset class that’s been overlooked by the rest of the world. That said, the issue isn’t about making dramatic swings in asset allocation that’s always at odds with the crowd’s bias. Rather, the crucial factor is gradually and continually taking profits while redeploying the proceeds into the unloved areas of the markets. Sure, the timing and trigger-point definitions for rebalancing are open for debate. The bottom line, however, is that you should be prepared to reduce exposure to those asset classes when they’ve delivered strong results and vice versa for assets at the opposite end of the performance spectrum. In other words, lower (higher) prices equate with higher (lower) expected returns when it comes to asset classes. It’s easy to see the logic in this strategy by reviewing history. Thanks to quirks in our wet-ware, however, it’s devilishly tough for most folks to pull off this feat in real time.