Three precautions need to be taken in the evaluation – 02/18/2023 – From Grão to Grão

Risk investments, as the name characterizes it, will always have some period of result below expectations. In theory, this statement seems almost obvious. However, when we are exposed in practice, the decision is usually driven by financial biases and we end up opting for one of two alternatives. I discuss the biases and how to evaluate the best decision.

If you have a really diversified portfolio, you have to understand that at all times, one of the asset classes is not performing satisfactorily.

That doesn’t mean there’s something wrong.

As I mentioned in a previous article, a diversified portfolio presented a result below the CDI in 50% of the years in the last decade. Even so, he was able to present a good result.

However, this also does not mean that we should not constantly reassess the portfolio and question whether the current position is the most appropriate one.

The first mistake when analyzing the portfolio is to evaluate the assets individually, disregarding the diversification properties.

Thus, the first bias we face is wanting to exchange everything that went wrong in the recent past for what performed well.

This effect is similar to what happens when we are in a traffic jam. The queue next to us starts to move and we are tempted to change.

Many times, when we manage to change queues, we notice that the queue we were in before begins to move faster.

The same effect usually occurs with investments if the analysis for the exchange is superficial. In investments, this effect is even worse than in traffic jams, as there is always some asset with better results in the short term.

The other decision taken by financial bias is to do nothing. Many who own an asset, which presented a negative result in the short term, only leave this asset if and when it returns to the previous maximum level.

Therefore, this investor misses opportunities, as he cannot face the fact that he may have made a wrong decision in the past.

In fact, the natural uncertainty of investments means that we are only sure which decision would have been the right one in the future.

The important thing is to understand if you are not being carried away by a behavioral bias, but are making the best decision with the data you have.

Making the decision rationally is simple.

Just think that instead of having a financial asset, you have the net financial resource of selling costs and evaluate where it should best be applied.

For this, the decision must consider the characteristics of diversification and the perspectives of assets for the coming years, starting today.

Therefore, the decision does not consider whether you won or lost, but how your equity can be more efficiently applied from now on.

Realize that the same decision process occurs when there is an asset that presented an excellent result. Maybe it’s time to trade this asset.

Three precautions must be taken in this analysis:
1- do not get carried away by results in the recent past;
2- avoid constant exchanges and consider diversification characteristics;
3- consider a prospective scenario, that is, a long-term future.

Considering these three precautions, periodically, it is important to assess whether the portfolio you have today is the one you should have if you were to start from scratch.

Michael Viriato is an investment advisor and founding partner of Investor House.

Talk directly to me via email.

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Book: The Journey to Financial Independence

summary

Introduction
Understand how you will achieve your financial independence
Living on an income is the last step on the journey to financial independence
These are the biggest questions about the journey to independence

Part 1 Construction of the plan
Chapter 1 The first step in building the blueprint for financial independence
Chapter 2 How do you define the rate of return in your plan for independence?
Chapter 3 Find out what equity you need to achieve your financial independence
Chapter 4 On your journey to independence, don’t overlook the importance of this factor
Chapter 5 Understand the two ways I applied to increase my saving capacity
Chapter 6 If You Double This Factor, Your Equity Can Multiply Much More
Chapter 7 Connecting the dots to build your plan

Part 2 Assembling the portfolio to lead you to financial independence
Chapter 8 Before making any investment, define these two factors
Fixed Income
Chapter 9 You should not build an income portfolio if you want to reach equity to live on income
Chapter 10 Avoid these two common fixed income investor mistakes
Chapter 11 In fixed income, does it pay to invest in private credit in relation to public credit?
Chapter 12 Discover how to win the private fixed income premium, but with low risk
Chapter 13 This is the simplest way to plan your financial independence with fixed income
Chapter 14 With our interest rates, find out if it pays to invest in dollars
Variable income
Chapter 15 Taking a risk can accelerate your journey to financial independence
Chapter 16 What is multimarket funds and how did they come about?
Chapter 17 Understand how to select hedge funds
Chapter 18 Real Estate Investment Funds
Chapter 19 Actions
Chapter 20 Alternative Investments
Chapter 21 When should I trade a risky investment that is not performing?
Investment funds and Private Pension

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