Investing isn't hard work. And that's just one of the problems.
For many folks, managing money is an exercise in frustration. We summon the skills that work so well in the rest of our lives, apply them to the financial markets -- and end up with lackluster results.
Here are just some of the qualities that help us at home and at the office, but leave us flailing around in the stock and bond markets.
We Stay Busy
If we want to get ahead at work or we want to whip the garden into shape, we get busy. Activity doesn't just seem virtuous. It also gives us a comforting sense of control, especially if we're dealing with a crisis.
But in the financial markets, staying busy is a bad idea. To be sure, if our portfolios are messed up, we will need to straighten things out initially. But once we've finished revamping our investments, often the wisest course is to keep activity to a minimum.
"The less investors do, the better their results," says Meir Statman, a finance professor at Santa Clara University in California. "If you trade, in all likelihood, you have a portfolio that's not diversified. You are hit with both unnecessary risk and trading costs."
That said, even investors with rock-solid portfolios will likely make a few trades each year. Every 12 months or so, you should rebalance, so you maintain your target portfolio percentages for sectors like large stocks, smaller companies, foreign shares and bonds. You might also do some occasional selling in your taxable account to realize tax losses.
We Work Hard
Athletes who train hard are more likely to win. Students who study conscientiously are more likely to get good grades. What about investors who diligently research their stocks? They'll probably earn mediocre returns.
The fact is, the markets are full of savvy investors, all hunting for cheap stocks. Result: If there are any bargains to be had, they don't stay that way for long. Indeed, much of the time, share prices are a pretty good reflection of currently available information.
"If you put in more effort, you'll end up with worse results," reckons Terry Burnham, co-author of "Mean Genes" and director of economics at Boston's Acadian Asset Management. "It's not the work. It's the action that comes out of the work that's the problem."
Every time we buy a supposedly bargain-priced stock, we incur commissions and other trading costs. In addition, if we trade in our taxable account, we may trigger big tax bills, further denting our returns.
We're Optimistic
Our hard work and our preference for activity lead us to trade too much and to make undiversified investment bets. But the damage to our portfolios is also driven by one of our more endearing traits: Our optimism.
"There is good evidence that optimists are more likely to remarry, they recover faster from surgery and they adjust more easily to life transitions like leaving home for college," Prof. Statman says. "But unrealistic optimism is something you want to check at the door when you enter the financial markets. Being optimistic about your investment abilities will lose you money."
We Look to the Past
Need to buy a refrigerator, find a new doctor or book a trip to Paris? For advice, we'll often turn to folks who have recently grappled with these issues -- and that's usually a smart strategy.
But with investments, relying on what's recently worked well can be a disaster. "In the financial markets, your backward-looking brain decides it likes a particular stock or a particular asset class," Mr. Burnham says. "The problem is, others with similar backward-looking brains reach the same conclusion. Now, you've got an investment that's popular -- and that makes it a bad investment. By definition, popular investments are overpriced."
We Buy Quality
When we shop for a new computer or a new stereo, we typically assume that greater sophistication is better, that reputation is worth something and that a product's price bears some relationship to its quality. But Wall Street is different.
If a mutual fund charges high fees, it is more likely to lag behind the market. If a company is widely admired, its shares may be overvalued. If an investment product is deemed sophisticated, it's often difficult to figure out how it will really perform.
"I never buy or recommend an investment product I couldn't explain to my 9-year-old son," says Allan Roth, a financial planner with Wealth Logic in Colorado Springs, Colo.
We Play to Win
We want to get that promotion, have a greener lawn than our neighbors and see our favorite "American Idol" win. "It's un-American to try to be average," Mr. Roth notes. "A tie is like kissing your sister."
Yet, in the financial markets, aiming for average is the surest way to come out ahead. We can't all outperform the market, because together we are the market. In fact, once investment costs are figured in, we will collectively trail the market averages.
What to do? We could tap into our optimism and commit to working harder and trading more. But all that will likely do is generate a fistful of investment costs and leave us lagging further behind the market averages.
That's why I favor building a globally diversified mix of index funds. You might put, say, 45% of your portfolio in an index fund that tracks the broad U.S. stock market, 15% in a foreign-stock index fund and 40% in a bond-index fund. You could build this sort of portfolio with mutual funds from Fidelity Investments, T. Rowe Price, Charles Schwab and Vanguard. Alternatively, you could use exchange-traded index funds.
Your index funds will simply replicate the performance of the underlying markets, minus a small sum for fund expenses. Sound dull? You may be more excited when you look at your results -- and you realize they're so much better than those earned by optimistic, hard-working active investors.
GETTING GOING
By JONATHAN CLEMENTS
