Would you invest differently given the chance?
It’s a bit disquieting that he used the rise of Nazi Germany as a metaphor, but author and venture capitalist Morgan Housel’s column The Full Reset provides a useful investment strategy as the new year approaches.
Mr. Housel writes that the reason the German military became so quickly and dangerously powerful in the 1930s was that it was built from scratch. Stripped of military capability after the First World War, the Germans built their armed forces with the most modern weapons and training, having no legacy organizational or equipment supplier issues to overcome.
Mr. Housel applied this idea to portfolios: “How many of us, if given a blank slate, would create an identical portfolio to the one we have now? Some would. Many of us would do something utterly different. But we don’t, because we’re burdened by past decisions and, like the military with an aging fleet, are unsure if updating our equipment is worth the high cost.”
Assessing your existing investments with a “would I buy this today?” is an important exercise and the beginning of a new year is a good time for it. There are, however, significant hurdles to extensive portfolio reshuffling, the most important of which is the potential cost.
Investors who pay commission for each transaction could find it prohibitively expensive to sell numerous positions and buy others. It’s also the case that research shows an inverse correlation between the number of portfolio transactions and investment returns – the more trades you make, the lower the performance tends to become.
The other major hurdle to big investment shifts is a psychological one – ego – and that is something that’s better to ignore. Selling an underperforming stock often carries with it an admission of failure, that an investment idea we were once excited by has turned out poorly. Maybe if we just wait a bit longer, we think, it will turn out we were right the whole time.
It’s a fine line to walk. Too many changes risk future performance, but falling in love with an investment and holding it even though the market’s clearly indicating it’s a piece of garbage is also a terrible idea. It can be uncomfortable to conduct a critical review of your portfolio holdings, but it’s an important exercise and a great way to start 2018.