YMM Reading List

Saturday, June 21, 2008

Fighting the plan: Avoiding the Investor Induced Oscillation

You've probably heard about automated investing. You set aside a regular allocation to your investment account on a monthly basis, and it is automatically invested according to your instructions. This is a great plan because it takes advantage of what's called "dollar cost averaging". Over time you buy more shares when the price is low and fewer when the price is higher.

The trouble comes when you interfere with the plan based on an emotional response to the latest CNBC story about the certain demise of the equity markets. You frantically contact your management company, sell shares when the price is low, then jump back in when the prices are higher and the news stories are all positive.

There is a comparison in aviation. It's called a pilot induced oscillation. When the pilot has the aircraft properly trimmed for a given airspeed, if everything else remains equal, the plane will maintain heading, airspeed, and altitude with almost no control inputs. If the pilot begins to put unnecessary corrections in, the airplane will go into bigger and bigger oscillations as the pilot chases the desired attitude. The more inputs the pilot makes the more unstable the airplane becomes.

Modern airplanes are designed so that if the airplane goes out of control the best course of action is simply to remove your hands and feet from the controls!

You should do the same thing with your investment strategy. Set up your regular investments and then just do periodic monitoring. I actually believe that if you buy the right stock funds (low fee, no-load equity funds or exchange traded funds) you probably do better by only checking the value 4 times a YEAR! More than that will tempt you to "fix" a problem and lead to an Investor Induced Oscillation (IIO).

Set a plan and let it ride!

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