The new year portfolio test all investors should take

Investing is a humbling business. And one of the most humbling aspects of investing is facing up to the results of your trading activities at the end of each year.

As the new year begins, now is the ideal time to assess the impact you had on your portfolio in 2023. Warning: you may be surprised by the results…

Look backward to improve your returns looking forward

So how can investors assess the impact their trading activities is having on their investment returns?

In the words Nicolai Tangen, the CEO of Norges Bank Investment Management, Norway's $1.4 trillion sovereign wealth fund: ‘The way to judge yourself is inertia analysis. Run your January 1 portfolio for the full year without any changes and compare it to your actual results. It's awful because some years you realize all you did was subtract value when you went into the office.’

In other words, the way to assess your impact is via an inertia analysis which compares your actual performance with what it would have been had if you had done nothing.

For example, if your actual performance was +8% whereas the portfolio you started the year with returned +10%, the inertia analysis shows your trading activities destroyed 2% of your portfolio’s value. Translation: your trading activities hindered your returns.

Conversely, if the portfolio you started the year with returned +6%, your trading activities added 2% to your portfolio’s value. Translation: your trading activities helped your returns.

The truth will set you free

Whilst sobering, the information derived from an inertia analysis is hugely valuable.

If you’re like the majority of investors, you’ll have been destroying value within your portfolio most years. The reason is simple: most trading decisions are driven by our emotional biases which drive us to take the wrong action at the wrong moment.

In contrast, the world’s most successful investors have an investment plan which they stick with regardless of what’s happening in markets.

That means they only buy stocks which meet their stringent buying criteria.

And it means they only sell stocks as and when an investment case has veered off track.

The rest is just market noise. And it is market noise that causes problems for most investors whenever they misinterpret it to be more important than it really is.

Add journaling into your investment process

A powerful strategy to channel your desire to trade into a more productive avenue, is to journal about your investment journey through the course of the year.

For example, prior to investing in a stock, write out your investment case/reasoning, your expected holding period, any relevant data-points, and your emotional state when you made the decision.

Write out your thoughts about the company’s results and news-flow at regular intervals.

And whenever you do decide to trade, write out your reasons for doing so. It’s also useful to categorise your buy and sell trades into separate buckets such as:

• Investment case changed;
• Dollar cost averaging;
• New idea;
• Tinkering.
  
  
  
  Come the end the year, these categories are likely to prove useful in learning the lessons which will help you improve your returns looking forward. Spoiler alert… if you’re actively learning those lessons each year, you’ll hopefully notice less trades are falling into the ‘tinkering’ category come the end of the year.
  
  

  Helpful quotes from Nicolai Tangen

  To help you process whatever you learn about yourself through your inertia analysis, here are a few useful quotes from Nicolai Tangen…
  ‘The fewer decisions you make the better they become.’
  ‘When you are young (25) you are in such a hurry despite having your whole life ahead of you. When you are about to die like me (57) only then you suddenly develop long term thinking.’
  ‘The biggest bias you have is you believe you don’t have any biases.’
  ‘If you call it gut feel no one believes in it but if you call it pattern recognition everyone believes in it even though it's the same thing.’
  ‘9 out of 10 drowning victims in Norway are men. Why? Men take more risk.’
  ‘The two most important traits in high achievers. 1.) bounce back factor - how well you bounce back after a loss 2.) debrief process - learning from wins and losses.’
  
  

  Doing nothing is often the hardest thing to do

  It’s time to be honest with yourself. Are you helping or hindering your investment returns? If you’re hindering them, don’t worry. You’re a member of a large and esteemed club of fellow investors.
  The key is to recognise that doing nothing may well be your optimal investment strategy most years—hard as it is to do.
  
  
  

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  Disclaimer: This article is prepared by Simon Turner. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.
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