Naive Optimism vs Informed Pessimism

By comparing, a group of students enrolled in Queens University's McColl School of Business in Charlotte, North Carolina to another comprised of four of the largest investment banks in the country, it is clearly evident that having a middle ground strategy in regards to investing can result in an overall smarter approach. This tactic is practiced by the advisors at Secrest Blakey & Associates, who have proven it to ensure long-term financial security.

Group one - "The Naïve" - included 20 students, juniors and seniors with a diverse mix of life experience and interests. In the scenario, each one was given $100,000 to invest in January. At the end of April, they shared their investment selections and the total amount of money produced in their portfolios.

As expected, "the Naïve" purchased equities in companies they cared about or found attractive, based on reporting in the financial press. The car guy invested in auto companies and the fashionista invested in apparel companies. Many invested in biotechnology stocks and social media companies, which had been producing excellent returns for the previous 12 months.

The college students were attracted to momentum. Common sense told them to find something riding an upward trend. With naïve optimism, they believed what is going up will continue to go up.

Group Two - "The Informed" - represented four of the largest investment banks in the country. Each one controls billions of dollars invested in the bond market. Like the students, they reported their investment performance at the end of April.

"The Informed" also followed their common strategies by betting against the tide. Interest rates had been going down for over 30 years, and were held artificially low over the past five years to spur economic growth. Common sense led them to believe that as the economy improved, eventually, the Federal Reserve would raise interest rates. With informed pessimism, the investment banks believed that what is going down must - at some point - go up.

Unfortunately, neither group received exactly what they initially predicted.
In March, the momentum in company stocks began to fall and wiped out the overall gains in the students' individual portfolios. Furthermore, during the month of January, interest rates started to fall, exactly the opposite of what "the Informed" anticipated.

The results of this particular exercise revealed and provided a few simple, but significant principles for investors to always remember:
• Time: Regardless of whether you are an expert or a novice, four months is not long enough to determine whether you are right about an investment choice. Even if your decision is correct, there is always the possibility of losing money in the stock market short term.
• Diversity: Combining stocks and bonds in a portfolio alleviates the necessity for your version of the common-sense solution to play out in the short term.
• Middle ground: The best investment attitude is neither naïve optimism nor informed pessimism. The best frame of mind when building for long-term financial security is somewhere in between.

James Blakey is a Certified Financial PlannerTM, with nearly 20 years of experience helping clients pursue rewarding lives. He is a senior partner in Secrest Blakey & Associates.