Become A Better Investor: Smart Habits And Increasing Phi (NASDAQ:DVY) (2024)

Alpha and beta are two risk and return variables that are largely beyond your control, according to a recent study. But phi is not.

What is phi?

The CFA Institute and State Street carried out a study to evaluate what motivates people to invest or not, and what leads them to make such investment decisions. The 18-month-long study consisted of extensive research, in-depth interviews with more than 200 global industry leaders, and survey results from 3,600 individual investors and 3,300 investment professionals across 20 countries. The study discovered a "hidden variable of performance" that explains the motivations behind decision making and what can drive successful long-term returns.

The variable is called phi.

Phi stands for purpose, habits, and incentives. All three govern the behaviors and actions of investment firms, investment professionals, and individual investors. Investment professionals that possess high phi means that their personal goals and values are aligned with those of their organization, but more importantly their clients. For individual investors to score a high phi they need to understand the purpose of what they're doing (i.e. how does this investment align with your long-term financial goals?).

The study points out that when the phi of the investment professional, the investment firm and their clients are aligned, there's a greater probability for sustainable organizational performance across market cycles as all are focused on achieving the long-term goals of the client. "Furthermore, phi drives the behaviors and attitudes individual investors must develop to reach higher levels of engagement and progress toward long-term goals."

The studies' results are discouraging, and perhaps not surprising. Only 17% of investment professionals scored high in phi, and 53% scored either low or having no phi. The investment industry is short term in nature. Investment professionals are mainly focused on short-term quarterly performance versus achieving clients' long-term goals. They're competitive and want to beat their respective benchmarks such as the S&P 500 index (SPY) as well as outperform their peers for asset-gathering purposes (i.e. to attract more clients).

Here's more on the studies' results.

• A one-point increase in phi is associated with 28% greater odds of excellent organizational performance, 55% greater odds of client satisfaction, and 57% greater odds of employee engagement.
• 28% of respondents said they remain in the investment management industry for the purpose of helping clients in achieving their financial goals.
• 62% of investment professionals believe their organization is acting in its own best interest rather than their clients' interests.
• 54% of retail investors believe that financial institutions are most likely to offer products and services in the firm's own best interest versus that of the client.
• 32% of retail investors attribute their long-term financial planning success to an advisor or other investment professional. They were more likely to credit themselves (55%) or friends or family (38%).

Short-term thinking has separated the investment professional's purpose of achieving clients' long-term goals. But you can't only blame investment firms for participating in short-term investing because clients are just as guilty. Investment professionals deal with external pressures from clients to deliver short-term performances. The study says short-term losses could drive an investor to terminate a relationship with a manager even if the investor benefits from the investment over the long term.

The average investor spends too much time trying to beat the market. Many engage in risky investment activities to do just that. Investors need to focus on behaviors and habits that are consistent with their goals. Changing old behaviors and bad habits is not easy and requires more than just being aware of the problem. Investors need to be more proactive and make sure they avoid money mistakes such as market timing, exuberant buying, and panic selling.

Studies show these are the major causes of underperformance and detrimental to long-term financial goals. If behavioral biases are influencing your investment decisions, learn more about psychological traps and the ways to not act irrationally in the market (buying high, selling low).

The chart below provided by J.P. Morgan Asset Management illustrates how short-term investing combined with emotional investing can diminish returns over time.

Average asset allocation investor return is based on an analysis by Dalbar Inc. where returns are annualized and represent the 20-year period ending 12/31/15. U.S. data as of 09/30/16 (Source: J.P. Morgan Asset Management)

Market researcher Dalbar Inc. found that there's 9 unique behaviors that lead to investor underperformance and irrational buying and selling (see chart below). Media response, herding, narrow framing, among others, are behaviors and habits that need to be changed to begin making smart investing decisions. Keep your cognitive and emotional biases in check. You'll see increased investment returns over the long term. To do this successfully, you need a vision (long-term perspective), values (investment strategy, patience, discipline, temperament), and setting goals (retirement income, buying a home, funding children's college).

(Source: "Quantitative Analysis of Investor Behavior, 2016," DALBAR, Inc. www.dalbar.com)

As a long-term investor, being patient and disciplined is crucial. Remember that value is created over time. Think long-term and make smart investing decisions driven by phi. Keep costs down (avoid excessive trading). Perform in-depth research before investing in any stock. Concentrate on the fundamentals of the business. Don't do "stupid research" as Peter Lynch said in a PBS interview in the mid-90s. "You buy some company that has no sales, no earnings, a terrible financial position and it goes down, you say, "Well, it's because of the programmed trading of those professionals," that's because you didn't do your homework."

An investor with good investing habits driven by purpose and goals will see the highest of returns and phi.

Reading recommendations

• Discovering Phi - Motivation as the Hidden Variable of Performance
• Your Brain On Investing In 5 Charts
• PBS Interview with Peter Lynch
• Book Review: Book of Value - The Fine Art of Investing Wisely

Christopher De Sousa