A couple of years ago, I arranged to purchase an eight-week old beagle for my wife's birthday. She named him Wally. Actually, she named him Wally about four decades ago when she first dreamed of having a beagle named Wally. Once Wally got his land legs, I soon found him doing the thing all dogs do. For no apparent reason, he would chase his tail. Everyone in the family thought it was so cute. Incredibly naïve, but cute.
Believe it or not, people who study these things call it "dog compulsive behavior." This is similar to the human "obsessive compulsive behavior." If we're to believe a recent study, one of the primary examples of obsessive compulsive behavior in humans is their uncanny ability to consistently chase investment performance (see, "Why 401k Investors Chase Performance – and How to Prevent It," FiduciaryNews.com, March 5).
We can attribute this unhelpful behavior to a couple of reasons. First, quite simply, there's greed. Despite all the plaintive warnings required by the SEC, too many investors – including ERISA plan sponsors – genuinely believe past performance guarantees future performance. How else do you explain all those sophisticates taken in by Madoff?
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Besides greed, though, is a common behavioral sin. This one's called "recency." It's a bias that pervades our culture. It's why many people think Joe Montana is a better quarterback than Otto Graham. It's why the average teenager goes gaga over Justin Timberlake but offers only a blank stare at the mention of Frank Sinatra. It's why today's politicians get their names on buildings formerly named after founding fathers. All of us place a greater value at things we've experienced recently. This generates a recency bias. And this, in turn, often leads to bad decisions.
Take, example, 401(k) plan sponsors. As the above link explains, studies have shown 401(k) plan sponsors routinely dump poorer performing plan options and replacing them with better performing plan options. The trouble is, of course, they're only looking at the last three years of performance. They fail to take into account the normal investment cycles. And guess what happens? Invariable, those new funds underperform the replaced funds as everything regresses to the mean over the next three years.
Investing is not for the faint-hearted. It requires a stern discipline. If investors don't have it, they will end up chasing performance – and their portfolios will suffer as they buy at the top. It takes a lot of courage to sell at the top and buy at the bottom. But, what else would you rather do? Sell high and buy low? There's a reason why the Dogs of the Dow strategy works – and it has nothing to do with obsessive compulsive behavior. And that's no tale.
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Christopher Carosa
Chris Carosa has been writing a weekly article and monthly column for BenefitsPRO online and BenefitsPRO Magazine since 2011 and is a nationally recognized award-winning writer, researcher and speaker. He’s written seven books, including From Cradle to Retire: The Child IRA; Hey! What’s My Number? – How to Increase the Odds You Will Retire in Comfort; A Pizza The Action: Everything I Ever Learned About Business I Learned By Working in a Pizza Stand at the Erie County Fair; and the widely acclaimed 401(k) Fiduciary Solutions. Carosa is also Chief Contributing Editor of the authoritative trade journal FiduciaryNews.com and publisher of the Mendon-Honeoye Falls-Lima Sentinel, a weekly community newspaper he founded in 1989. Currently serving as President of the National Society of Newspaper Columnists and with more than 1,000 articles published in various publications, he appears regularly in the national media. A “parallel” entrepreneur, he actively runs a handful of businesses, including a small boutique investment adviser, providing hands-on experience for his writing. A trained astrophysicist, he also holds an MBA and has been designated a Certified Trust and Financial Advisor. Share your thoughts and story ideas with him through Facebook (https://www.facebook.com/christophercarosa/)and Twitter (https://twitter.com/ChrisCarosa).
