Forecasts for subdued, lower returns over the medium-to-long term from diversified investment portfolios underscores the case of being a realistic investor and consumer.
This means being realistic in your expectations for investment returns, being realistic in recognising that investors have self-destructive behavioural traits and being realistic in understanding that controlling your spending habits is critical for wealth creation.
Investors who are not realistic in their expectations for returns – particularly in a lower-return environment – are vulnerable to taking excessive risks and abandoning carefully-constructed portfolios in their pursuit of unrealistic returns.
Further, investors with unrealistic expectations are more likely to fall into the trap of switching to the latest highest-performing investment funds and making short-term, emotionally-driven investment decisions, again in their efforts to boost returns.
If tempted to follow such a performance-chasing strategy, keep in mind that Vanguard research suggests that the latest top-performing funds have a strong likelihood of becoming future underperformers.
Realistic investors recognise that we have negative behavioural traits that can hinder our investment success.
Self-destructive traits include overconfidence, inertia, greed, finding illusory comfort in following the investment herd, being easily distracted by short-term events, and an excessive fear of loss clouding our investment decisions.
Behavioural economists also point out “narrow framing”, which is focusing on a specific part of a portfolio, such as a single investment, rather than on the portfolio as a whole.
Another behavioural trait which can trouble investors is “confirmation bias”. This involves deciding on a course of action and then looking around for evidence to support that action while blocking out contrary opinions and research.
Practical ways to keep undesirable behavioural traits in check include setting clear goals, creating an appropriately-diversified portfolio, regularly rebalancing your portfolio back to its target long-term asset allocation and minimising investment costs. In other words, following sound investment practices.
A basic rule for investment success is to try to spend less than you earn so as to have money left over to invest. It is a matter of being realistic about your spending and recognising its link to your ability to create wealth.
Conspicuous spenders are typically not conspicuous savers.
Are you a realist in your investing and your spending? Being a realist can move you closer to achieving your investment objectives, and is an approach to managing money that is clearly under your control.
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Written by Robin Bowerman, Head of Corporate Affairs at Vanguard.Reproduced with permission of Vanguard Investments Australia Ltd
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