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Anchors keep boats tied to a certain point and prevent them from drifting in new directions. Investors often have anchors, too—certain beliefs or points of reference that limit their perspective. And if left unchecked, these anchors may limit our investment opportunities.
Investors don’t necessarily anchor on relevant information, and when they rely too heavily on this information, they may lose sight of other outcomes.
For example, U.S. markets have been on a great run, and some investors have become anchored to the idea that the U.S. markets will continue to lead. But history shows that domestic markets aren’t always in favor. There have been years when international markets led, and the U.S. market lagged. Investors who anchor their portfolios to the U.S. market may miss out on good performance from areas of the world.
Anchoring has been especially prevalent in the fixed income or bond markets in recent years. Since interest rates have been near historic lows, it’s logical to expect that interest rates will be higher in the future. But no one knows when rates might rise. Some investors became anchored to the idea of higher interest rates and decided to sell out of bonds since bond prices fall when interest rates rise. The trouble is, interest rates haven’t risen. This year in fact, rates have fallen and investors who avoided bonds because they were anchored to the idea of higher rates may have missed out on good gains from bonds.
Anchoring is usually a way that investors try to deal with uncertainty. Because we can’t know what the future holds, we cling to something that feels assured, like the resilience of U.S. markets or the inevitability of higher interest rates even when these assumptions don’t lead us to make good investment decisions.
Anchors Away: 3 Ways to Counteract Anchoring
How can we make better decisions and avoid getting anchored to one possibility?
1. Follow a disciplined strategy
No one can predict the market. Rather than trying to guess how the market might change in the future, we encourage investors to seek out a strategy like our Upgrading approach that we use to manage the Upgrader Funds. With Upgrading, we aim to invest based on what’s doing well now and we change our portfolios as markets change.
2. Adapt to changing markets
An active strategy like Upgrading aims to help us adapt when markets change. Upgrading invests in mutual funds and ETFs, which make it easy to shift our portfolios when market leadership changes.
3. Consider many possibilities
One way investors can avoid getting anchored to any one area of the stock or bond market is to consider many different areas of the market. If you’re only looking at growth funds, you’re apt to miss out on stronger performance from value funds. If you consider both growth and value funds, you’ll have a better chance at investing in growth funds when they are doing well and investing in value funds when they’re in favor.
That’s why the Upgrading strategy we use to manage the Upgrader Funds includes many different kinds of funds, such as growth and value funds, international and domestic funds, and large- and small-cap funds. We apply this same approach for bond investing, where we evaluate government and corporate bonds, short- and intermediate-term bonds, and lower and higher quality bonds.