Wednesday, November 13, 2013

Investing for Survival

 Investing  for Survival—Behavioral Biases from Capital Spectator


Missing The Forest For The Trees. This is one of the more subtle biases that damage our investment decisions. How many times have you locked your focus on the big winner or loser in your portfolio and allowed that slice of the asset allocation to influence your thinking? It happens to all of us, of course, but it’s no less pernicious as a factor that keeps us from focusing on the far more relevant issue of the portfolio overall. This is a problem that lurks in every corner of designing and managing asset allocation. For instance, we’re hard wired to pick only those assets that we think will deliver strong performance and shun those that are perceived to be dogs. But in the critical task of building and managing a portfolio of multiple asset classes, looking at the elephant’s tail in isolation of the entire beast is setting us up for trouble. The goal, after all, is holding a portfolio that’s reasonably close to optimal, based on our risk tolerance, investment goals, time horizon, and so on. It’d be nice if we could identify ex ante the best-performing asset classes as a regular routine, and thereby ignore everything else. But that’s virtually impossible as a long-term proposition, at least for most investors. The next best thing is designing a portfolio that keeps financial risk to a minimum while shooting for average to above-average returns. For most of us that means spending most of our time managing a portfolio, as opposed to a collection of individually chosen assets. But far too few investors take the time to emphasize this broad view. For instance, how does your portfolio compare on various measures of risk and performance with a passive asset allocation index, such as the Global Market Index? If you’re not sure, you’re missing the forest for the trees. It's hard to manage your portfolio if you only see it in terms of its pieces.

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