Note to Self: Don't Let Investors Get Hurt by FOMO

Here's a note I wrote to myself about the most effective ways I've helped clients avoid being hurt by FOMO. With the recent market surge and the post-election rally, I thought you might find some useful ideas to implement for yourself and your clients.

Getting Ready for FOMO

Whenever there's big market news or heightened excitement, I notice my clients start to worry about missing out. The best way I manage their FOMO (Fear of Missing Out) is by discussing my investment process. However, to discuss it effectively, I need to ensure my process is strong. Here are some best practices I've developed for communicating with my clients to prevent them from getting caught up and hurt by FOMO.

The Peak Excitement Dilemma

The biggest issue with FOMO for investors is when market excitement reaches its peak, and trading volumes soar; that's when certain new investors often get lured in, especially as investments might be at their peak value. Emotions are high, and there’s this compelling urge to profit, particularly if one is holding too much cash. I often see people, influenced by negative news or worries about long-term issues like government debt or political instability, hesitate too long before entering the market. The recent presidential election, for instance, has left many people on the sidelines. Some of those people are coming to me to ease that pain. But I can help them get invested without getting hurt by investing too aggressively in overpriced stocks.

Staying Grounded Increases Returns

I've found that sitting on the sidelines during a bull market can be quite painful. My focus is to highlight key process elements that help my clients remain grounded. The key to managing FOMO starts with a strong initial conversation when clients first join, which helps them stay steady during volatile times. It also helps existing clients resist the urge to take a balanced portfolio and to become too aggressive at the wrong time. This approach is equally beneficial during downturns when they might feel the opposite fear and think about exiting at the wrong moments.

I use a disciplined approach to protect clients from FOMO, starting by rationally weighting investments based on factors like valuation, quality, margins, and sentiment. My strategies consider a broad spectrum of elements including value, growth, stability, volatility, and size. Although most factors are measurable, softer aspects like management quality or industry dynamics require a systematic method to rank and prioritize for a comprehensive strategy.

Rebalancing Strategies

Rebalancing is another critical aspect I use to protect my clients from FOMO. Most investors don’t fully grasp that a significant part of performance comes not just from security selection but from how I manage risk and construct the portfolio. I discuss how I weigh investments and outline my plan for rebalancing.

For example, in some of my proprietary strategies, I manage a 30-stock portfolio where I set a minimum weight constraint of around 1.6% and a maximum of 6.2%. I also allow positions to drift from their target weights by up to 30% and set a trade threshold to avoid excessive transactions, which I've found significantly impacts results.

Define the Investment Universe and Performance Expectations

I'm clear with my clients about what the investment universe looks like and why certain investments are included or excluded. I inform them about minimum liquidity requirements and reasons for excluding certain types of companies, like REITs or MLPs, if they don't align with the portfolio goals. Discussing benchmarks provides context for performance evaluation.

Portfolio Review Frequency

After discussing the benchmarks and position limits, I explain how often I review investments and my criteria for re-buying stocks that were previously sold but now qualify again. I decide on reassessment frequency, balancing thorough oversight with transaction minimization to avoid performance drag. A maximum portfolio drift constraint, like a mean deviation limit, is part of this process.

Clear Buy and Sell Rules

I define my buying and selling rules clearly, detailing what triggers a buy, a trim, or an exit, along with diversification rules by sector or company type. This disciplined approach reassures clients, but I also share that I allow for flexibility to ensure continuous improvement, embracing the Japanese concept of Kaizen.

Long Term Strategy Implemented with Adaptive Tactics

My investment philosophy is based on asking the question “What do I know to be true and will it likely to be true over the long-term?” With that said, the tactics used must be adaptable. If I were still operating with tactics from 30 years ago, the results would likely be disappointing. Core principles like discounted cash flow remain, but tactics must evolve with changes in market structure, trading mechanics, and broader economic and industry trends. My trading rules are based on rational factors and long-term fundamentals that are not likely to change in the future.

Communicating Process Purpose

To effectively manage FOMO, I explain the purpose of my investment process, how it's designed to navigate market fluctuations, and that while the strategy is rooted in long-term principles, tactics will adapt to current conditions. Consistent improvement, disciplined sizing, diversification, and rebalancing are key to balancing potential returns with risk.

Avoiding Market Timing

I advise against extreme moves like going fully into cash, highlighting the risks of market timing. I set guidelines for cash allocation and discuss expected volatility levels, emphasizing that focusing on valuations and expected returns is more reliable than reacting to price swings. Cash should ideally be used to compound over time, which is crucial regardless of market sentiment.

I hope this helps in managing my clients' FOMO or provides insights for those refining their own processes. Clear, deliberate planning leads to consistent long-term results. I’d love to hear your thoughts on enhancing these key areas.