The illusion of control: Our compulsion to do something

by Pop on February 2, 2010

Post image for The illusion of control: Our compulsion to <em>do something</em>

Take charge, seize the day, lose money

If you’re stopping by from the Carnival of Personal Finance at Get Rich Slowly, welcome! Thank you for coming. Be sure to check out my other pop art. And hopefully, you’ll like what you see enough to subscribe!

Have you heard about how much money you can make in Forex? How about managed futures? Or gold? Or timber? No, seriously, timber. A salesman recently showed me a chart of timber prices over the last decade superimposed on a chart of stock and bond prices. Man, timber blew them away.

In fact, more than any other time, I’m seeing dozens of salesmen claiming to have the “next big thing” to improve my diversification and prevent another lost decade from smothering my investments. I’m not going to lie, every once in a while, the idea piqued my interest. Maybe I’ll just move 5% of my portfolio into a managed futures fund. Hell, I couldn’t do worse than I did a couple years ago, right?

Let’s face it. The market flattened us like pancakes, danced on our limp bodies, and screamed “What are you going to do about that, sucka?!” And naturally, we’re bouncing to our feet and trying to find a way we can get even. That’s what these new salesmen know. In short, they’re offering us the illusion of control over our investing future.

Being in control makes us feel happy. This isn’t just anecdotal—it’s been proven in study after study that feeling in control produces optimism and high self-esteem. In contrast, studies have shown the absence of control produces withdrawal and depression. (Edit: There are lots of studies on the illusion of control, its causes and its effects. The two linked look at the effect of having power on the illusion and how it might be broken. But take a look at this NY Times post that’s more germane to the control/happiness link.)

So it’s really hard for a marketer to come up with a more seductive pitch than the take charge, can do, seize control of your future stuff we’ve been seeing lately. Take a look at this Charles Schwab commercial selling just that.

Dispelling the illusion

Of course, what they’re selling isn’t worth the mashed pulp it’s printed on. Making a decision, in and of itself, doesn’t help your investments at all. It just muddies things up. I haven’t seen Schwab running advertisements screaming, “Our investors did twice as well as investors at other brokerages.” And you know why? Because Schwab investors went down with everyone else. Similarly, gold, for all the hype lately, isn’t even back to its 1980 peak, if you adjust for inflation.

Rationally, you know you have no control over the market, and as a result, little control over the results of your own portfolio. But you’re not emotionally impervious to pitches like the one above—promises that you can take control if you just do something. However, there are ways to limit the damage.

1. Give yourself a sandbox.

In a sandbox, kids rule. They can build castles, get dirty, dig holes…whatever. But out of the sandbox, they play by the grown-up rules. The sandbox is an outlet to do whatever they want. I’m convinced that if we didn’t have sandboxes, toddlers would wig out with crayons on the walls more often than they already do.

So, even though you rationally know you’d do better by sticking to a traditional, low-cost asset allocation, set aside 5% of your portfolio to try to beat the market. Put it in gold, or biotech stocks, or timber, or whatever else strikes your fancy. Simply giving yourself a little control, studies have shown, will make you a happier investor.

And the key: If you lose money by making active decisions, as you likely will, you’ll have limited the damage. You’re not likely to make that 5% go to zero. But even if you fall for some seriously bad investments and lose 50%, the overall impact on your portfolio will only be 2.5%. That’s a lot better than messing around with the whole shebang.

2. Do something, but do the right thing.

If you insist on taking action, do the things that you know you should be doing but might have put off for a while. One easy one to knock off is to rebalance your portfolio. Bring it back in line with an allocation that’s right for your age.

If I find myself with an itchy trigger finger, sometimes I rebalance in the middle of the year, even though my normal schedule is only to rebalance once, toward the end of the year. Yes, it’s basically a form of market-timing. So why do I do this? It’s a whole lot better than letting that itchy trigger finger wander over to a new asset class or make an extreme change in my balance of stocks and bonds.

You can also trade-up your mutual funds for those with lower costs. S&P 500 index funds all basically do the same thing. So there’s no reason you should pay a 0.50% expense ratio in one, when you could get a 0.20% ratio in another. Vanguard is a good source for low-fee funds, but Charles Schwab is actually a low cost leader right now for most major index funds. (See? I see the bad and the good in companies.) Around tax time, you can also sell losing index funds and buy similar ones immediately, giving yourself a tax break.

To be honest, you might not walk away from the exercise completely satisfied. You’ll know you’ll have just danced around the edges. But the point of investing isn’t to satisfy your ego-driven need to feel in charge. Because sometimes, you’ll never be in charge, no matter how hard you try.

So what are you going to do about that, sucka?


{ 4 comments… read them below or add one }

Rob Bennett February 6, 2010 at 10:14 am

I just discovered this blog from the link at Consumerism Commentary. I love the graphics!

I agree with the main point being made in this blog entry, Pop. But I think you take the idea too far. You are essentially endorsing Buy-and-Hold, which means that you stick with the same stock allocation even when stocks are selling at insanely dangerous prices. I think that’s a case where you really do need to be willing to do something (lower your stock allocation) to protect your portfolio.

You mentioned endorsing calculators in your “About” section. I would be grateful if you would take a look at mine. It’s called The Stock-Return Predictor. It performs a regression analysis of the historical stock-return data to reveal the most likely 10-year return starting from any of the possible valuation levels. If you go to the home page of my blog, you’ll see a button marked “Return Predictor” on the left-hand side of the page in the event that you want to check it out.



Pop February 6, 2010 at 5:59 pm

Hey Rob,

Thanks for the comment. Sometimes I’m skeptical as to whether most investors can properly assess whether valuations are high or low. And even if they could assess it, I’m not sure how many of us can consistently muster the chutzpah to be a contrarian when the market’s doing well. If you went that route, I guess the ideal situation would be to have a strategy that you could implement automatically, without even thinking. (Maybe fundamental indexing? I don’t know…)

I’ll definitely check the calculators out.

- Pop

Rob Bennett February 7, 2010 at 4:50 pm

I’m not sure how many of us can consistently muster the chutzpah to be a contrarian when the market’s doing well.

I think the key is to have all of the “experts” encouraging us to increase or lower our stock allocations in response to price changes. Lots of investors don’t follow investing that closely and tend to do what the big names suggest. We need a lot more encouragement to engage in long-term timing, in my view.


Mike February 24, 2010 at 9:36 am

Hey guys,

Nice article Pop. About the whole buy and hold, it has been shown that with a low cost ETF or Index fund that it is about the best you can do. If you go and read about CA and VA (Cost and Value averaging) then you will see that these are the two best ways to invest and inherently are mildly contrarian.
CA allows yo to both over and undershoot whereas VA ensures a final sum – if you can muster the required investments.

Personally I didn’t invest much during the boom as I wrote a program to value the markets independently of my own lack of ability to keep focus – I have however done very well in the last 16 months. I never discuss the actual figures of my investments and my only outstanding regret is not having enough money when my program said “Buy you fool, why aren’t you buying?”

This allows me to remove my emotions from the equation and has worked well for me so far. I wish you all well and hope you find your own way to success.
Personal hint: The markets are too powerful to control but they are not of themselves clever. As long as our population remains industrious there will be money to be made on the markets.

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