The System Wants You to Act

I recently spoke with  Peter Lazaroff , CFA, CFP®, the Chief Investment Officer at  Plancorp , which manages over $6 billion of client assets.

In the first few minutes, he said something that caught my attention:

“The system is set up to make you feel like you must act.”

In other areas of life, acting increases your chances of succeeding, so why is money different?

The Joy of Gains & The Pain from Loss

Think of the financial apps you have on your phone. Each notifies you to fund your account, trade, check the price of a rising or falling asset, and if your portfolio is up or down.

How do you think this affects your psyche?

“People who check their portfolio are more likely to see a loss because the market is up 54% of days,” Peter told me. “You’ve got about a 50/50 chance of checking your portfolio and seeing a loss.”

In the 1970’s Daniel Kahneman and Amos Tversky, famous for Thinking Fast and Slow,  conducted a study  that suggests we feel the pain of loss about twice as strongly as the joy of a gain.

If there’s a 50/50 chance of opening your portfolio and seeing a loss and loss hurts us twice as much as gains please us, that means that checking your portfolio will lead to:

A) A mild pleasure response if you’re up

B) A strong stress response if you’re down

Imagine I ask you to flip a coin. If it lands on heads, you lose $2. If it lands on tails, you gain $1. Would you play my game?

Transaction Frequency and Portfolio Performance

But each of these platforms want you to spend time on their app.

“The way it’s designed is to get you to keep logging in and doing something.” Peter told me. “They have behavioral scientists on the backend designing their interface to make you feel like you must act.”

I’m not under the impression that you’re going to throw your iPhone away and go pick up a Razor, though that would be cool. But you should know that your best interests are seldom aligned with the best interests of the financial system. They want you to act, but oftentimes you shouldn’t.

“99.9% of the time, the best thing to do with your portfolio is nothing.” Peter said.

Enter the punch card method.

“You have a punch card with 20 slots on it. Each time you make a change to your portfolio, you punch a hole in a slot. If you hit 20, you can’t make anymore for the rest of your life,” he said. “When you know you can only make a limited number of changes, you’re going to think more deeply each change and you’re only going to implement your best ideas.”

The financial system spends more than $20 billion annually to convince you to buy individual stocks and to trade them frequently. In reality, that’s a losing strategy (for us, at least).

“People trade too much,” Peter said. “They make too many changes. In reality, the more you trade, the worse your returns are and the more you look, the worse your returns are.

Let’s play devil’s advocate.

To hell with your advice, Peter. What if I want to trade and I want to trade often?

 In a 2000 study , researchers found that the 20% of investors who traded most frequently underperformed the least active investors by 6.5% annually.

To be clear: Investors who actively traded, devoting more time and resources into their investing, performed much worse than investors who bought an index fund and did nothing.

The financial system wants you to check your portfolio and take action frequently. Your portfolio and quality of life call for the opposite.

Connect with Peter Lazaroff