Olympics & Investing: Behavior and Unpredictable Events Can Cause Havoc
There are roughly 6.5 billion people on planet Earth. Of those with access to electricity, it is estimated that over 75% of the available sentient population watched the opening ceremony of the 2012 Olympic games, irrespective of longitude of time or latitude of climate. Nearly 3 billion people will watch every day. That’s a staggering number of people whose attention, for whatever reason, is fixed on the same thing.
What can we learn about investing from the Olympic games? Believe it or not, plenty. We can actually become better investors by using the Olympics as our training ground.
“Okay Bryan, this still isn’t making sense,” is probably what you’re thinking. Give me a minute, and it will all be crystal clear.
I actually have an assignment for you. Since (according to statistics) the majority of you will be tuning-in to the Olympic games at some point during the days ahead, I want you to pay close attention how often your mood changes during the events. If you are a die-hard fan, you’ll notice that when the United States does well, your overall mood improves. On the other hand, if the United States or your home country is defeated, you’ll experience a marked change in your emotion. That’s really not breaking news. Psychologists have been studying the effects of sporting events and our ability to make wise decisions for quite some time now.
Sporting Events and Investment Behavior
According to research studies of how sports-induced sentiment affects investment behavior, our tendency to react without thinking (and basically make dumb investment decisions) rises incredibly whenever our favorite teams lose. Decisions like selling at a loss out of fear and bouncing in and out of the market instead of sticking to original long-term goals.
A recent study published in The Journal of Empirical Finance reported investor reactions to NFL team losses. The study especially focused on unexpected losses when teams were expected to win big according to careful analysis and odds based on player past performance.
When things didn’t go as expected and monetary losses were involved, there were surprising connections to investment behavior. Researchers conducting the study observed trader moods that became so depressed that buys and sells at the next day’s opening was greatly increased. This was true even when investors had to wait through the weekend to conduct trades on Monday morning.
What does this mean?
The Results of Emotion Driven Investment Decisions
This type of behavior and these emotion-driven investment decisions have a profound effect on the longevity of an investor’s trading career.
Investors pack it up and quit for good, every day. There are two main reasons for giving up.
- They have suffered a loss that is greater than they can live with
- They can’t handle the stress of the volatility of the market
Protecting Against Loss (or Reason Number 1)
Of course, with investing there is always risk, but the likelihood of the first reason happening to you can be greatly reduced with a prudent investment plan. Cut costs down to a bare minimum by using a Registered Investment Advisory Firm (fiduciaries who charge on a fee only basis) such as Blue Ocean Portfolios.
Your portfolio should contain broadly diversified investments that don’t track together. This means they need to be unrelated, so that when one is falling the others are rising and vice-versa. You’ll also reduce the likelihood of loss by carefully planning out your risk tolerance based on your financial situation and your short and long term goals. A person who is 45 with $100,000 to invest is going to take a much different approach than a 25 year old with $10,000 to invest. Finally, regular rebalancing is vital.
How Does Blue Ocean Portfolios Rebalance?
Rebalancing forces you to harvest profits from the best performing sectors and buy into the lower, or poorer performing sectors. You’ll be buying low and selling high, the age old, clear cut, proven market strategy.
The decision to rebalance can become emotionally driven if certain investments are gaining and the investor wants to wait it out to see how high a well performing sector will rise. Of course, this has the potential of starting the whole “market timing” cycle, which generally ends up being a mistake. Instead, Blue Ocean Portfolios has adopted the Constant Proportionality™ approach, which relies on the fact that prices are unpredictable and random, and the best way to deal with randomness is to be a constant. Taking emotions or predictions out of the quotient, we use a Constant Proportionality™ uses a drift allowance principle, which automatically rebalances back to the target allocation whenever a component hits or exceeds its drift tolerance. It’s similar to trimming the sails in order to stay on course.
How is Constant Proportionality™ Different?
Constant Proportionality™ differs from traditional rebalancing performed by many wealth managers and financial advisors. While many advisors focus on quarterly or semi-annual rebalancing, this method has been proven to miss prime market opportunities.
In January of 2008, Dr. Gobind Daryanani detailed Constant Proportionality™ in his ‘Opportunistic Rebalancing’ research, which was published by the Journal of Financial Planning. His research detailed the problems involved with quarterly or annual rebalancing, which of course, involved the missed opportunities created by market volatility. By utilizing his strategy of rebalancing whenever a 20% deviation occurred in an asset class, he was able to enhance returns by .50%.
His conclusion was this:
“Opportunistic rebalancing not only controls portfolio risk, but also provides significant return improvements by capturing sporadic buy-low/sell-high opportunities as asset classes drift relative to each other…This contrarian approach of buying low and selling high can generate additional returns, assuming the parameters for rebalancing are set appropriately.”
Volatility in the market is generally what investors fear, but when using Constant Proportionality™, volatility is viewed as part of the process that can actually lead to gains.
Protecting Against Stress (or Reason Number 2)
Handling investment stress, whether it has to do with your sports team losing, fear-based reports from the media, or other circumstances beyond our control, is greatly reduced when we understand our investment plan, along with our long and short-term goals.
Markets are efficient and they will always come back around, even though they will go through dips and drops along the way. The first step to avoiding emotional investing is through the knowledge that volatility in the market actually works for you, not against you.
Secondly, realizing that we are emotional beings and purposefully guarding against this very predictable behavior is also key. Successful investors don’t try to deny the fact that they are tempted by fear to pull out of the market. Instead, they guard themselves by turning off the media, not buying into the “predictors,” the “gurus” and the self-proclaimed market timers. They realize that no one can predict the future and all it takes is one catastrophic event, flood, nuclear explosion, oil spill, terrorist attack, rumor of war, scandal, or death of a CEO to turn everything they thought was solid into mush.
At Blue Ocean Portfolios, your Registered Investment Advisor builds your portfolio with strategic asset allocations representing a broad and diverse portfolio with these uncertainties in mind.
When you think about the research just on the sports losses, it’s easy to understand. Your brain works like this, (just think about it logically)…
You bet on a team that was highly favored. You had winning odds and were told you’d enjoy a big win. When it doesn’t happen and you lose, your mind immediately goes to your investments with comparative thinking. You say to yourself, “If my team didn’t win even though the players had been carefully analyzed and all the information available had been taken into consideration, how can I believe that my investments won’t turn out the same? If I can lose $500 on this sporting event tonight, who’s to say I won’t lose my entire nest egg Monday morning?” Fear sets in and you wait in a panic, counting down the hours until the market opens.
Blue Ocean Portfolios doesn’t base your investment strategy on past performance, predictions, and doesn’t engage in active management. Because they don’t take that approach, you can sleep well at night. Regardless of what tragedy or catastrophic event occurs tomorrow, your investments are guarded against loss.
Is there still a certain amount of risk? Of course. That’s part of investing. But there is a way to greatly reduce the potential for loss.
During the days ahead, try to be hyper-aware of the way you react to the wins and losses you will experience during the 2012 Olympics. Your emotions will roller coaster again and again. No one wants to live this way with their investment strategy and you don’t have to!
To learn more, please take advantage of our free resources at The Financial Coach Show website and continue to follow Brian Binkholder, author, motivational speaker and business advisor. He has trusted Blue Ocean Portfolios with his own investments, and is a living testimony to the fact that prudent investing that allows you to sleep at night and enjoy life is a reality! Is it yours?