Just as a coach would stand in front of their team, an investor stands in front of the market believing one of three things:
- “I can find better players.”
- “I can win with my players.”
- “I can make my players better.”
Coach A sees what’s in front of her and believes she can do better. She knows there are risks in changing players or strategy, but thinks she has a good enough understanding of the game to make a change.
Coach B accepts her players for what they are and doesn’t think that she will find much value in the free agent market. She believes that she can win with her team “as is.”
Coach C doesn’t want to take on the risks of changing players, but she doesn’t want to just sit back and accept the present reality either. She continually analyzes her team and has identified ways to put her players in a better position to win.
Whether it’s Wall Street or the NFL, few can predict the right formula and maintain success over the long haul.
Investors walk into the market with similar thoughts about their portfolio:
- The active investor mindset: “I will find inefficiencies in the market and new ways to improve my expected returns.”
- The passive investor mindset: “I will accept my current portfolio and the expected returns that come with it.”
- The evidence-based investor mindset: “I will leverage historical data, financial theory, and human psychology to maximize my current portfolio and improve the expected return.”
An active investor sets out not just to make a profit, but also to beat the industry benchmark. This drive forces them to take on more risk because merely doing what everyone else is doing will not achieve the results they are looking for. An active investor, just like Coach A, can get hot and find a lot of success. But whether it’s Wall Street or the NFL, few can predict the right formula and maintain success over the long haul.
A passive investor believes the market is functioning efficiently and there is no risk worth taking that will consistently beat the market. A passive investor accepts the benchmark return and finds an advantage through savings on fees, taxes, and trades costs. This investor, just like Coach B, is not taking into consideration the empirical evidence that all players or investments aren’t the same.
An evidence-based investor knows that not all stocks and bonds are equal. Searching out how each investment is different will give the investor an understanding of why each investment’s return is different. An evidence-based coach trusts her players to play like pros over the course of the season, sometimes only needing to change positions or tactics to thrive. The evidence-based investor trusts that investments will perform to their mean or average given a long-term time horizon, sometimes only needing to change investment vehicles to thrive.
In the end, each style of coaching and investing has found both success and failure. The difference lies in how much risk are you willing to take on. Do you understand what is or is not in your control?
Looking at your portfolio, which investor mindset aligns with your thinking? Which approach do you see winning in the long run?
Jed Collins, CFP® serves as a relationship manager at Brighton Jones.
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