I have had quite a few emails from newsletter subscribers worried about the recent ups and downs of the market and their short term returns.
This got me thinking about goals and how goal setting may unintentionally be lowering your investment returns.
Here is why.
Be careful of short term goals
It is generally a good idea for you to set goals in terms of what return you want to achieve with your investments. After all that is why you have saved and are investing – to grow your savings into real wealth.
However, by setting goals you must be careful that you don’t place too much weight on short term returns as this may cause you to deviate from your investment strategy because of short term losses because, for example, selling your profitable investment and holding onto losing investments when markets fall – known as the disposition effect.
And deeper underlying problem
But there is also another problem if you set goals for your investments.
This may lead you to see profitable investment as success and losses as failure.
You know that over the short term investment returns are all over the place and can be so random that even the best investors experience losses – not just over the short term (a few months) but also over longer periods such as a few years.
If you see a profitable period as proof that your investment strategy is successful, it may lead you to increase your risk taking (to be fully invested or even take on debt to invest).
In the same way you may see losing periods as evidence that your investment strategy is not working and that you have to change it, resulting in you ignoring really attractive investments when you are losing money.
How to overcome this problem
The best way for you to step off the emotional rollercoaster of feeling good when you are winning and feeling bad when you are losing is to set your investment goal in terms of a process rather than a goal or outcome (targeted return or end amount).
The best way to do this is to do exactly what we have done with the strategy we follow in the Quant Value newsletter:
- Invest using a written time tested investment strategy that has been successful over long periods of time in up and down markets,
- Review the strategy at least twice a year to make sure you stay committed,
- Develop a checklist to make sure that you follow the strategy with each of your investments.
Manage market ups and downs
The only way to manage market ups and downs is to know that even your best investments may go up or down over the short term because of the news or world events.
This is a simple fact of investing.
But, if you buy the right investments (that fit with your investment strategy) for the right reasons, you have already met your investment goals because you know that over the long term these investments will give you a very satisfactory return.
A different example
A good example of following a process and not having goals has been best explained a number of times by Warren Buffett.
Imagine you are a baseball hitter (or cricket batsman) that focuses only on swinging when the ball comes to you at a certain position. This of course does not mean that you will hit the ball a long way every time, but it means that when you do the ball is likely to go a long way.
This same idea applies if you invest only when a company meets your investment strategy. You are already successful because you are buying the right investment for the right reason.
The same as healthy eating
It is also the same if you generally follow a healthy diet.
Does that mean that you always feel on top of the world?
Most likely not, but you know that over the long term this diet will keep you healthy and will give you a long healthy life well into old age.
In life as well as in investing doing the right things over the long term gives you the best results.
But, if you put pressure on yourself to reach certain short-term goals, it will most likely result in you doing the wrong things (buying the wrong investments).
Good long-term investment returns are the result of many successful individual investments made over weeks, months, years and decades combined with a risk management strategy such as the stop-loss strategy the newsletter follows.
Wishing you profitable investing