Even the "best portfolio ever" is one behavioral mistake from blowing up, says Carl Richards, director of investor education for the BAM Alliance and creator of the weekly Sketch Guy column in The New York Times.
"As an industry, we need to get a lot better about helping people to behave correctly," says Richards, adding, "The best investment portfolio, the best-designed portfolio is only as good as your ability to behave with it."
Richards used some of his simple sketches to illustrate why people make crazy decisions around money during a recent webcast from the Investment Management Consultants Association.
"Stocks are the only thing that humans rush to buy when they're marked up and hurry to return when they're on sale," Richards said during the webcast. "Can you imagine behaving that way with your new car? You show up at the Audi dealership, and you walk in and you say 'I need a new A4 Allroad.' And they say, 'you're in luck! We just marked them up 30%!' And you say 'Awesome, I'll take three!' It doesn't happen."
Richards discussed what he sees as three big behavioral mistakes that all humans make – but that especially affect financial decisions – and some possible solutions.
"We all get greedy when everyone else is greedy and fearful when everyone else is fearful," Richards said. "And there's good reasons for it. That type of behavior has kept us alive as a species but it's terrible for us as investors."
Here are three common mistakes that clients — and advisors — make:
1. Mistake: Confusing results with activity
So often, Richards says, advisors and clients confuse activity with results.
"How often do you get that phone call, 'Have you seen the markets? Shouldn't we be doing something?'" Richards said. "Confusing activity with results is one of the big mistakes that we both as advisors and as human beings, investors make."
Solution: Understand the difference.
"Helping clients [and] first of all understanding that ourselves – that our value is not in activity," Richards said. "We should be paid for telling people to do nothing, when doing nothing is the right thing to do. We shouldn't be bashful about it. And helping clients understand the difference between activity and results."
To help illustrate his point, Richards quoted Warren Buffett: "Benign neglect, bordering on sloth, remains the hallmark of our investment process."
2. Mistake: Recency bias
According to Richards, "recency bias" (or the "recency effect") is the idea that people take the recent past and project it indefinitely onto the future.
