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Monkeying Around

By: Frank Armstrong

As seen on Forbes.

When researchers gave a bunch of monkeys an apple, they were happy. When the researchers gave a different bunch of monkeys two apples, they were happy, but not much more so than the first bunch. But, when the researchers took one of the apples away from the second bunch, they had some seriously unhappy monkeys on their hands. Every monkey ended up with one apple, but the second group had experienced a loss! They didn’t take it very well.

Why even bring this up? Because it partially explains why some individuals are hard wired to fail as investors. And, because after a few rough weeks in the world’s markets, some investors might be tempted to monkey with their portfolios.

This little experiment and lots of other research on loss aversion with humans illustrates that we hate loss twice as much as we enjoy gain. And loss aversion drives far too many investors to act against their better interest.

Some investors refuse to take any risk at all. Perhaps they were previously burned (the dot-com bubble, or 2008 near meltdown). Perhaps they just grew up over cautious. Or perhaps their grandparents told them about the Depression. Even though they know that global stock market returns have always far exceeded bond returns, they don’t want to experience loss. So, many of them are doomed to never reach their economic goals.

Another group is stuck in an endless cycle of buying high and selling low and then wondering why they aren’t successful in the capital markets. At the first sign of trouble, they are out of here. Then they wait to “see what’s going to happen” only to reenter the market after it has once again peaked. Not everybody does this, but enough of them do so that the median return for all investors is far, far below market returns. Cash flows to equity funds go heavily negative during market downturns, only to recover at near all-time high market levels. You can readily see that this isn’t a formula for investment success.

In the monkeys’ defense there is no evidence that any of those in the second group attempted to sell their remaining apple as a result of their loss. But, human investors might. After 40 years of counseling investors, I have learned that the temptation to sell during declines is overwhelming for some investors. They know in their heads that markets go up and down in unpredictable ways. They know that markets have been an extraordinary generator of wealth if you just give them time to do their work. They know that market timing hasn’t ever worked consistently. They know, they know, but they just can’t resist selling during declines.  Many become serial offenders. The vast majority regret their decision later, but then it’s too late.

We are certainly not advocating excessive risk taking by investors. The decision about how to weigh the risk necessary to meet the investor’s goals against their downside risk tolerance is the critical investment decision. However, once that issue is resolved, the obviously superior strategy is to remain fully invested in the appropriate asset allocation plan.

So, don’t be monkeying around with your financial future. It’s uncomfortable at times when Chicken Little is predicting the imminent fall of the sky. But, stay the course. It’s the right thing to do.