Placing Constraints On Yourself

A few weeks ago I wrote about The Psychology of Sitting in Cash and a reader left a great comment about how he has tried to solve this problem in his own portfolio using the financial crisis as an example:

I limit myself to 10% adjustments monthly, most months I moved about 10% from equities to cash. I did get back in afterwards, at more like 5% a month, and I’ll admit it was hard to buy, but I was driven by the fear of missing the recovery.

I love the idea of placing constraints on yourself as an investor to defeat psychological pitfalls. This individual limited the amout of his portfolio that he could make changes to. I think this type of patient approach is a great way to manage impulse decisions. And the important thing is that this is what works for him. Others utilize different methods, both on themselves and even their employees. The following was described by Frank Portnoy in his book Wait: The Art and Science of Delay:

One hedge fund manager told me that he doesn’t give his junior employees access to real-time price information because they would be glued to their trading screens, like teenagers playing video games. Instead, he sounds like an old-style parent: he wants his employees to read and think. It isn’t easy to find investments that will generate high returns, and they typically don’t pop up in the news.

To paraphrase Fred Schwed, there are certain things that can’t be taught, but only learned through experience. Is real-time price information really that important for investors? I don’t recommend that we go back to a time when it was difficult to get real-time data, but I’d venture to guess it has hurt far more people than it’s helped.

When people ask me what I do for a living there are time when I’ll tell them I’m paid to think. Sometimes that thinking leads to taking action. Most of the time it leads to more thinking and no actions taken. It’s easy to confuse activity with results, even if that activity does no good most of the time. But that’s exactly what many investors do who don’t have the proper constraints built into their process.

I’m not suggesting that every investor has to implement these specific constraints to guide their actions. But all investors do have to figure out which constraints to place on themselves based on their past history and personality traits. Everyone has their blind spots. These are a few more examples I’ve seen from others over the years:

  • Don’t invest in anything you don’t understand.
  • Stay within your circle of competence.
  • Never pay more than a certain fee level for investment products.
  • Give yourself 5-10% of your portfolio to speculate to appease your gambling instincts.
  • No more than a certain percentage invested in any one security or asset class.
  • Only look at your portfolio value monthly, quarterly, annually, etc.
  • Rebalance on a set calendar schedule or when your allocation weights hit a certain band outside of their target.
  • Wait at least a week to implement a new investment decision.
  • Talk to an unbiased outside observer about every big portfolio move you’re about to make.
  • Actively seek out opposing viewpoints on your current investment stance.
  • Keep a decision journal and review before making any new portfolio moves.
  • Only allow a certain number of transactions per year.

Now is probably a good time to review your own constraints within your investment plan. Interest rates are low. Stock prices are high. This stage in the cycle can lead people to relax their risk controls and press the issue if they’re not careful.

I’m of the opinion that most investors would be better off making fewer decisions and getting rid of any unnecessary clutter from their portfolios and investment process. Placing constraints on yourself is a great way to do this. The first step is understanding yourself and your own flaws, something that’s not as easy as it sounds, since the easiest person to fool is often yourself.

Wait: The Art and Science of Delay

Further Reading:
Doing Nothing Is a Decision
Risk Management Always Matters
Louis CK on Risk Management

Sign up for email updates and my monthly newsletter by clicking here.

Follow me on Twitter: @awealthofcs

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

The Compound Media, Inc., an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here:

Please see disclosures here.

What's been said:

Discussions found on the web
  1. John Thees commented on Apr 20

    I would add to the list, automate the execution of major decisions major decisions if possible. For example, several years ago I decided to put 5% of my stock portfolio into a precious metals fund and 8% into a REIT index fund. I set up an automated investment program with Vanguard to automatically invest a set amount each month for 24 months that would get me to those levels over that time period. Doing it this way made life easy because I did not have to decide every month, is this the day I should execute an exchange? After two stressless years I was fully invested in those funds and ready to rebalance as necessary.

    • Ben commented on Apr 20

      I agree. Automating good decisions ahead of time is one of the best things investors can do to stay out of their own way. I also like averaging in over time to make sure you stick with your plan. Minimizing stress is something not enough investors think about when making their decisions.

      • John Thees commented on Apr 20

        I agree and averaging in is what automating over a period of time does.

  2. Grant commented on Apr 20

    Interesting post. My main constraint, which fits my personality, is to choose the simplest solution to a problem. That’s why I like the Boglehead 3 fund solution. I live in Canada, so I invest 20% of my after tax income each month in a Canadian equity ETF, international ETF and Canadian Total Bond ETF according to my risk tolerance, and rebalance once a year, if needed. I spend about 10 minutes a month on this strategy. There is a huge advantage to simplicity.

    • Ben commented on Apr 21

      Nice — Occam’s Razor. I’m a fan of simplifying as well. I recommend that portfolio to plenty of people as a way to make their finances easier. It’s also been a difficult one to beat, even for many professional investors.

  3. Tyler Cruickshank commented on Apr 20

    Thanks for the good post. I use and like Personal Capital as a account aggregator and tracker of spending etc, but one of my big beefs is they really highlight your net worth. I do like that you can get email updates which include spending etc but they always include daily performance of positions and your New Net Worth. I wish they would leave this out because it is very unhelpful.

    • Ben commented on Apr 21

      I do like the aggregation, but I agree that seeing that number every time you log-in is probably overkill. Maybe updating your net worth once a year could be helpful but not every single day.

  4. Mark H commented on Apr 20

    One other possibility that would probably help for someone like me is not being able to see performance outside of annual or quarterly reports unless my portfolio is down more than some amount specified in advance

    • Ben commented on Apr 21

      Don’t look is very good advice. The more you look at your mkt value the more tempted you are to make changes. Good one.