There is nothing special about another orbit of the Earth around the sun that makes it essential to measure investment performance. However, the end of a calendar year is a natural point for investors to take stock of their recent performance. Hence, this is the time of year when investors tend to publish portfolio reviews. This is something I feel torn about. On the one hand, I genuinely enjoy reading about other investors' progress or pitfalls. However, learning about other investors' performance can lead to several biases.
Investment Behavioural Biases
These biases are usually based on a form of myopia – an unduly short-term focus. A year is a relatively short period to test an investment strategy, and continually comparing short-term performance to other investors is unlikely to help bring Investment success. After a good year, investors may succumb to hubris and become overconfident. Merriam-Webster says that:
In classical Greek tragedy, hubris was often a fatal shortcoming that brought about the fall of the tragic hero. Typically, overconfidence led the hero to attempt to overstep the boundaries of human limitations and assume a godlike status, and the gods inevitably humbled the offender with a sharp reminder of his or her mortality.
Overconfidence often leads investors to be overweight positions, believing they know more about a company or industry than they actually do. This is a dangerous combination. The market gods are great at humbling those who succumb to investing hubris.
On the flip side, seeing others generate high returns in a poor year can lead investors to conclude that they should modify their investment strategy. If the underperformance lasts many years, a serious look into what has gone wrong may be required. However, if an investment strategy is based on sound principles, switching is more likely to cause future underperformance. There are at least three significant mistakes investors can make:
Mistake 1 - Missing the role that luck plays
Short-term investment results are a mix of both skill and luck. When an investor has excellent results but holds a few risky and illiquid stocks, the outcome is far more likely to have been due to luck than skill, particularly when one or two stocks are responsible for all the gains. While skill can persist, luck is likely to be mean reverting.
Mistake 2 - Having a different risk tolerance
The best investment strategy is one you can stick…
