When was the last time you looked at a brokerage statement? Hopefully you don’t check yours too often, but from the information provided, how much was related to investment performance? Maybe you were able to see how you were doing in absolute, dollar terms, but what about relative to a benchmark? What about performance relative to a customized benchmark designed to track a particular strategy or investment objective? Most brokerage statements offer little, if any, information on how your overall portfolio is doing. Often just showing unrealized gains and losses, it’s hard to tell if a portfolio is performing well; it’s especially harder if your investments are spread across multiple accounts.

From a behavioral finance perspective, reporting limited information is understandable. Most individuals think about their wealth in terms of dollars—not in percentages or relative to a benchmark—so why show more than that? Many managers are happy to hide behind this; clients, for example, may be oblivious to the fact that their actively managed stock portfolio is trailing the S&P 500 because, hey, it’s increased $x over the past year! That can be a double-edged sword, though; flip those gains to losses, and clients may (irrationally) be less tolerant. “I don’t care if my account is down less than the market, I’ve still lost $x!” Yet, thanks to compounding returns, the “eighth wonder of the world,” those dollar losses typically diminish over time. It’s rare (though not impossible) to have long-term positions with 10+ years of history and see unrealized losses on your account statement.

Unfortunately, hiding behind those dollar gains, may lie an inconvenient truth: although you made money, your portfolio could have done better.

Assuming you can evaluate performance beyond unrealized gains/losses, defining “better” can still be subjective. Opportunity costs grow with time (“if only I had invested in x” becomes “if only I had invested in x, y, and z.”), so there could be an endless combination of possibilities that may have improved performance. I’m certainly not advocating restless nights over not having bought and held Apple back in the 90s. Further, I don’t advise “chasing” performance, and constantly switching strategies when presented with a better-performing alternative. Rather, the point here is to highlight why many investors, even sophisticated ones, tend to stick with strategies that are too risky, too expensive, or too often try to time the market, even when they’re underperforming. Ignorance may be remedied—it could be as simple as comparing an actively managed stock portfolio against a passive benchmark or monitoring a high-cost manager vs. a lower cost alternative— but how do we fix complacency?

When evaluating your own investment strategy, behavioral finance again offers insight into why we often choose the status quo.

Endowment Effect: A principle in behavioral psychology that describes the tendency of people to value an object that they own higher than they would value the same object if they didn’t own it

[Source: Corporate Finance Institute]

It doesn’t take much for individuals to assume “ownership” of something. Think how quickly we assign sentimental value to gifts we don’t need yet never get rid of. Once something “belongs” to us, we innately form an emotional attachment. That attachment is further strengthened if it’s something we have built (a.k.a. the “Ikea Effect”). As a result, things that we build are valued not just from a material standpoint but also as a part of our identity. This helps explain why investors may remain committed to an underperforming strategy—because the investments are not just a reflection of net worth, but also self-worth.

“...our perceived self-efficacy—that is, our beliefs about our own abilities to perform well and exert control over our lives—is an important component of our overall mental health. People who believe in their own self-efficacy are better at coping with challenges, recover more quickly from failures or setbacks, and are less vulnerable to stress and depression.”

- Why do we place disproportionately high value on things we helped to create?

 The Decision Lab

Competence and autonomy are inherent motivators. The more competent we feel and the more autonomy we are given, the higher our perceived self-worth. When making investment decisions, or even when hiring someone else to do it, both can reflect our self-efficacy. Often the success/failure of an investment strategy is in the eyes of the beholder and there’s nothing necessarily wrong with that. Sourcing, researching, and committing to a strategy takes a lot of time, effort, and patience. We take ownership of those decisions. So, no matter how innocuous it may seem, making a change to an investment portfolio is more emotional than many are willing to admit. We are also naturally loss averse and thus tend to ignore, sometimes willfully, both the actual costs and opportunity costs of maintaining status quo, even if there may be a better path forward.

So how can we come to terms with a sub-optimal portfolio when it’s so hard to acknowledge? As noted, most brokerage statements allow you to avoid the situation altogether by providing little information. These and other basic “performance reports” often convey a false sense of competence as those long-term unrealized gains suggest you’ve done a good job. Why get help if you think you’re doing just fine?

Hiring an advisor isn’t a panacea either; advisors are prone to the same cognitive biases, though we may be more aware of them and better equipped to help you address yours. It’s good to have a fiduciary who not only helps set objective goals but can identify opportunity costs beforehand and ensure that those costs don’t outweigh the benefits of staying the course. Separating net-worth from self-worth is ultimately up the individual, but, at the very least, it helps to have a trusted partner help with the former while you improve the latter.  

If you have any comments, questions, or would like to learn more about how SineCera Capita provides customized, transparent reporting for our clients, please contact us.

Best Regards,

Adam J. Packer, CFA®, CAIA®

Chief Investment Officer | SineCera Capital