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www.insideHALTON.com · OAKVILLE BEAVER Thursday, August 30, 2012 · 14 Outsmarting the market does not work when investing Your biggest risk when investing may be you. Ironically, it is your intelligence that may hurt you the most. There have been many human behavior studies that have improved our understanding of our investing habits. One of these studies was published in the Wall Street Journal. Extensive research shows that investing is best done over a long time frame. Short-term investment decisions that try and outsmart the market do not work. The long-term approach theory is supported by years of academic research. Standard and Poor's market data shows that managers who make short-term predictions and investment changes fail to beat the market averages over the long-term after trading costs are considered. Short-term market volatility is random. Yes, many investors attempt to trade for short-term gain; however, that approach is not supported by the academic community. A recent study published in the Journal of Neuroscience explains the brain's natural tendency when making decisions. Our decision making ability makes us the most intelligent species on the planet but it can be a disadvantage when making investment decisions. This intellectual advantage comes from the frontopolar cortex which is directly behind your forehead. Researchers from three American universities compared subjects who had damage to this area with groups with no damage. Participants played four separate slot machines that were programmed to produce random results. It is that Dollars & Sense By Peter Watson short-term randomness that is similar to short-term market results. The two healthy control groups made their bet based primarily on the results of the last two outcomes. The group with damage to the frontopolar cortex based their decisions on the cumulative reward history. The advantage was held by those with frontopolar cortex damage where their short-term decision making ability was affected. It's that short-term thinking that costs individual investors significantly. The healthy individuals expected the short-term results to continue and bet accordingly. They lost. The Wall Street Journal article used Standard & Poor's mutual fund performance figures to illustrate the failings of the human brain when investing. In 2009, only 49 per cent of the top half of mutual fund performers remained in the top half one year later. Add one year and only 24 percent remained in the upper half. For two years in a row, the results indicated that half of the above average funds performed well and half did not. Those odds are no different than flipping a coin. The consensus is that short-term investing doesn't work. Based on investment research, Standard & Poor's historic performance data and scientific research shows the limitations of the human brain. An intelligent investor should accept his or her short-term investment limitation skills and focus on the long-term time frame. A simple and easy way of achieving success is to plan for your longterm financial needs and then develop a written plan outlining what you need to do every year. That will eventually help you achieve your goals. Focus on what you can control. Concentrate on your long-term plan and avoid the risk of short-term investing. That will be your formula for financial success. -- Submitted by Peter Watson, MBA, CFP, R.F.P., CIM, FCSI.