Stopping Destructive Investment Behavior

Last Updated Apr 15, 2009 7:28 PM EDT

Three years ago, when my son Kevin turned eight, I decided to teach him how to develop a portfolio that would beat Wall Street. The simple lesson was to own a handful of the lowest cost, most diversified index funds and forget about it. What I didn't expect was a blurring of the teacher-student line that eventually had Kevin pointing out my own irrational behavior.

I'd successfully convinced Kevin that investing was long-term and that it didn't matter much how the market did in any one year. Especially not in the case of money he didn't need for a long time.

Binge surfing
But then one day Kevin caught me on the Internet obsessively checking up on the market. He said it was about ten times a day, but my guess is that it was -- and remains -- much more often. As children do, he noticed an inconsistency between what I said and what I actually did. Welcome to the real world, kid.

My first instinct was to explain that keeping tabs on the market was necessary for my work as a financial planner. Truth be told, though, I'm all about the long run. I'd actually be proud to tell a client that I had no idea what the market had done in the last half hour.

That really made me think. I figured that I ended up wasting a half hour a day, or roughly 125 hours a year in lost productivity. Also, studies show that a dollar lost hurts about twice as much as the pleasure from a dollar gained, so I was getting far more pain than pleasure out of my time-consuming behavior.

The answer, of course, should have been a no-brainer -- stop this destructive behavior. Yet it wasn't easy to do. Like most dieters, I was successful for a few days and then went back to binge stock surfing.

The illusion of control
So I called some of my friends who are experts in the field of behavioral finance, the emotional component of economics. I spoke to folks like William Bernstein, Jason Zweig, and Jonathan Clements. They all happen to be nice people, which may account for why they didn't just come right out and tell me I was nuts. Instead, they were kind enough to make excuses for me.

Jason came up with one great theory known as the "illusion of control" -- the notion that if I keep tabs on the market, I can exert some sort of control on its outcome. This is similar to the person that hits the elevator call button every ten seconds, as if that will make it come more quickly. I'm usually pushing it every five seconds.

Look in the mirror
Stopping irrational behavior may seem to be a simple task but, as I found out, it's not an easy one. Humans have many ingrained behaviors that cause us to invest poorly and to repeat mistakes our entire lives. Recognizing some of those patterns and trying to control them is the best we can hope for.

I get much of my material from observing investment behavior of others and by watching the financial services industry and the media. I also get a good bit of my material by looking in a mirror.

Image via Flickr user LollyKnit, CC 2.0

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    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.