Machines expect to lose occasionally and expect to manage their losses as part of the standard process of realizing positive long-run compound rates. Giving yourself permission to fail (for the right reasons) will help you stay process-oriented, like a machine.
#4 Understand what builds wealth
It takes money to make money. Yes, the ancient adage is true – but not for the reasons many people think. For years the financial services industry conditioned investors and their Advisors to focus on the simple short-term rate of return instead of the long-term compound rate.
Why would they do that? It’s simple…
The short-term return, often, looks good. Plus, the Advisor is afraid that if the short-term performance does not meet the client’s expectations, they may leave.
Also, if an Advisor performs poorly during a short stretch of time (a quarter), by using tight windows to evaluate an investment, it is easier for the Advisor to refocus her client’s attention on the ‘great’ quarter that is coming up, and “forget” about the weak previous quarter. As an example, an Advisor may choose to talk about year-to-date numbers because the end of last year was ugly.
How many retail investors claim that they focus on the long-term, but really make decisions based on the short-term? These examples and many others lead to increased short-term risk and remove the focus from the long-term compound rate. Consider this example:
You have two portfolios that start with $10,000. After five years they look like this:
- Portfolio A: $12,000
- Portfolio B: $18,000
Which client would be more satisfied if the following year looked like this? Pick one:
- Portfolio A: 7% ($840 gain)
- Portfolio B: 5% ($900 gain)
Unfortunately, most clients would think Portfolio A that made 7% was the “better” portfolio for the year, even though Portfolio B made more money. Wealth is determined by dollars, not by percentages – and as you can see, it takes money to make money. What matters most is the value of the portfolio, not the rate of return applied to it during the short-term.
The Best Investors Don’t Just Use Machines, They Learn from Them
People are amazing, beautiful and awesome creatures! But, most people are programmed to be lousy investors. Of course, this condition is why Financial Advisors exist.
The human mind, despite its immense power and potential, is programmed to make snap decisions. As a result, people make many more incorrect decisions than correct ones, and this programming applies exponentially to financial investing.
Bottomline, cracking the code to long-term wealth creation is improved when we learn to think like a machine.
This article was written by Chris Shuba, founder of Helios Quantitative Research, a participant in the ETF Strategist Channel.
- Provide clients a better asset management experience
- Reduce client fees by up to 30%
- Drive higher revenues by up to 50%
[1] Correct answer looks like this: $1.05 + $.05 = $1.10; $1.05 – $.05 = $1.00. Incorrect answer looks like this: $1.00 + $.10 = $1.10; $1.00 – $.10 = $.90.