People adopted a number of bad investment practices in the 1990s, and they continue to follow them. One simple strategy that will boost returns is to rebalance a portfolio periodically. Sell what’s done well and buy more of what’s declined until your portfolio is back to your planned allocation. That’s a way to sell high and buy low. But few people take event his simple step, according to a new study. The academic world says this is due to a behavior they call “anchoring.” Whatever you want to call it, it’s not good financial management.
In fact, many people don’t even adjust their portfolios on an annual basis, says Victor Ricciardi, a professor of finance at Goucher College in Baltimore, Md., despite the fact that an increasing number of companies allow investors to automatically set up an annual rebalancing online.
Ricciardi—who has done extensive research in the fields of behavioral finance and the psychology of risk—attributes this lack of proactive investment behavior to what he calls “the anchoring effect.” The anchoring effect causes individuals to cling to a belief that may or may not be true, and to base their decisions for the future on that belief. The inertia and inattention that this leads to can have detrimental effects on their retirement accounts.
“In the late 1990s, for example, the stock market was going up and people simply followed suit and kept buying more and more shares,” Ricciardi says. “Even though that resulted in a bubble situation, investors’ general tendency was to just let things be without bothering to take any timely decisions with respect to asset allocation and risk—decisions that could have helped them fare better in the future, when the markets turned.”