With just a handful of trading days remaining, 2025 has turned out to be a good year for financial markets. Double-digit gains were the norm.
It’s much easier to make money when everything keeps going up. The temptation for investors is to start taking more risk than they are able to handle.
Over the past few months, I have received many phone calls from clients who all of the sudden want to sell “boring” assets in their portfolios and start moving into more speculative individual stocks. Whether this makes sense is based on each individual investor’s risk profile. But the danger in this approach is that investors are becoming too confident in their investing abilities.
Underperforming
Ten years ago, I mentioned this issue. Not much has changed in the subsequent decade. I cited Tony Giordano, a senior financial adviser with Vanguard, who quoted an article that appeared in the Journal of Economic Perspectives in 2015, titled “Overconfident investors, predictable returns, and excessive trading.”
“The report said, ‘Investors attribute strong portfolio performance and high returns to their skills, which leads to self-assurance. When the same investors experience poor performance and low returns, they attribute it to bad luck.
The result: persistent overconfidence. It’s that persistent overconfidence which can lead to poor investment decisions.
“Call it greed or whatever, but I’ve seen too many times where after a good year in the market, [an investor] loses sight of his financial goals and needs, and decides to chase after higher and higher returns. And you all know what eventually happens, and it’s not pretty.’”
In a seminal study by Brad M. Barber and Terrance Odean, it was found that individual investors who traded most actively earned annual returns that were about three percentage points lower than the market average (1999). In other words, their confidence in their ability to outperform the market translated into worse performance than a passive buy-and-hold strategy.
Similarly, Dalbar’s annual Quantitative Analysis of Investor Behavior repeatedly shows that the average equity investor significantly underperforms market indices over time. For example, over a 20-year period, using recent data, the S&P 500 returned about 9.85% annually, yet the average equity investor earned only around 5.19% – a gap largely attributable to poor timing decisions driven by emotion and overconfidence.
These studies confirm what many financial advisers experience firsthand: Investors believe they know more than they actually do. They trade frequently, chase past performance, and ignore diversification – all because of an inflated sense of certainty.
Stay strong
Resist the temptation. Giordano sums it up when he says, “If strong market performance makes you headstrong with the possibility of quick returns, avoid the temptation to go after investments that will expose you to more risk than you’d feel comfortable with under ordinary circumstances. On the flip side, if poor market performance tempts you to flee to cash, consider the longer-term implications, which include missing a potential market rebound and losing future growth opportunities.”
Asset allocation
I have said 1,000 times, but it bears repeating. Creating your asset allocation, or the mix of stocks, bonds, and cash in your portfolio, is the single most important task that an investor has to face. Many studies have shown that the proportion of stocks, bonds, and cash held in a portfolio has a greater effect on its returns and volatility than the individual investments that are chosen.
That is why after assessing one’s investment goals, it’s of the utmost importance to create an allocation that can help you achieve the aforementioned goals.
Especially after the market run-up of the past few years, it’s important to reassess your portfolio. Much has changed in the world over the past year. Investors should take the time to make sure that their portfolios are well positioned for current conditions.
In time periods when stock returns are much higher, many investors can find themselves with portfolios much more heavily tilted toward stocks then when they started out. One of the most overlooked aspects in long-term investing is the need to rebalance a portfolio.
Rebalancing is important for two main reasons. First of all, it keeps your portfolio in tune with your long-term goals. Secondly, it keeps your asset allocation in line with your risk level.
What’s the upshot of all of this? Stay the course that you started out with. Part of your financial plan took into account good years in the market. Take the money and say thanks. But don’t get overconfident and start getting more and more aggressive; you could end up making costly mistakes. If you follow your asset allocation and rebalance your portfolio, you will be able to achieve your financial goals.
The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc. or its affiliates.
aaron@lighthousecapital.co.il
Aaron Katsman is the author of Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing.