The new year often brings ambitious resolutions
– often revolving around ways to perfect yourself. Perhaps some of your clients have even shared their resolutions with you.
But what if this year you suggested a resolution to them – at least in the realm of their financial plan? And what if that resolution was for them to embrace their imperfection
. It may seem counterintuitive to them, but committing to this new resolution could contribute to their long-term financial success.
For instance, you could encourage your clients to change their approach to investment decision-making
in 2015: rather than striving to make the perfect investment decision consistently – have them commit to employing a disciplined investment strategy – one that could lead to unbiased, consistent choices.
After all, making “perfect” investment decisions consistently is hard – even for professional investors. Not only are markets hard to predict – but common human biases
often jeopardize our ability to make rational investment decisions. For example, we have a tendency to overestimate our ability to control
outcomes. This can lead us to attribute success to our own skill, while failures are ascribed to bad luck.
Winning over the skeptics
Some of your clients might be skeptical
about this new approach. So, try this scenario on them:
Imagine that you receive $12,000 on January 1 every single year for 10 years. But you have to invest the money into a well-diversified U.S. stock portfolio each year – and you can’t take it out of the market again.
Would it be best to invest the full sum all at once? Or to invest it a little bit at a time (say $1,000 per month)? Or should you attempt to invest it on the day the market hits its low point for the year?
Of course, investing at the lowest point each year yields the highest cumulative investment return – 117% for the 10-year period ending December 2013. However, study upon study has shown that perfectly timing the markets is virtually impossible
The next best strategy is to invest the money in one lump sum
at the beginning of each calendar year. In fact, this approach would have yielded a cumulative return of 88% for the 10-year period ending December 2013. That’s because investing in January offers investors the longest exposure to the market for that calendar year.
Assumes a one-time investment investment of $12,000 per year into a hypothetical U.S. index portfolio represented by the Russell 3000® Index with dividends reinvested and no withdrawals between January 1, 2004 and December 31, 2013. Source: Russell Investments. Cash return based on return of $12,000 invested each year in a hypothetical portfolio of 3-month Treasury bonds represented by the Citigroup 3 month U.S. Treasury Bill Index without any withdrawals between January 1, 2004 and December 31, 2013. Source: Citigroup. Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.
What if your client is still not persuaded? Have them consider that for someone investing $10,000 for 10 years starting on January 1, 2004, missing the top five market-return days would cost 34% in ending wealth
for the 10-year period.
Assumes a one-time investment of $10,000 in a hypothetical U.S. equity index portfolio represented by the Russell 3000® Index on January 1, 2004 with dividends reinvested and no withdrawals. Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.
The bottom line
When it comes to investing, expertise and strategy are important. But help your clients make sure that a focus on making the perfect investment decision doesn’t stop them from putting strategies like compounding to work for them. Over the long run, a disciplined approach will help them far more than the occasional perfect decision.
Share the latest Investor newsletter with your clients to help them adopt a new year’s resolution that can help them achieve their long-term financial goals.