Portfolio Management Software vs. Your Brain

Posted on August 22, 2012 at 12:24 PM PDT by

Millions of people file their taxes on websites without a blink. Yet few think that they need portfolio management software to tell them what to buy and sell in their IRAs. Let’s do a thought experiment on that.

Is your garage packed to the rafters? Is your home a veritable museum of your life, with shelves of record albums (but no turntable), magazines you will not read, movie tickets and keychains and broken knobs from things long lost, or gone, or meaningless?

Your mental garage vs. portfolio management software

Congratulations, you’re perfectly normal. You can blame your growing kids, or your spouse, or even that your house or apartment is too small. But you know in your heart that possessions are like gas — they expand to fill the space they’re in, relentlessly.

A recent opinion column in The New York Times on our crazy desire to keep things forever led us to this interesting fact. Our hoarding habits are costing us, and more than just mentally:

This is the cultural dilemma that supports a multibillion-dollar storage industry: we love our stuff, and we also dream of being free of it. According to the Self Storage Association, 1 in 10 American households rents a storage unit. And still our closets, attics, basements and garages are jampacked with stuff. The Department of Energy estimates that 25 percent of people who have two-car garages don’t park their cars inside.

Which reminded us of a quote from the English designer William Morris: “Have nothing in your house that you do not know to be useful, or believe to be beautiful.”

Naturally, we find parallels in investing, specifically portfolio management software. People tend to treat their portfolios much as they do their overstuffed, jumbled garages: Jammed with once-glorious stuff, reminders of good times past, hinting at some future self who will someday again pick up the golf clubs, break out those cross-country skis, and mow the lawn rather than hire a service. All good intentions.

Consider your investments. Do you even remember when you bought that great income stock, at your uncle’s recommendation? What was the maturity of the bonds in that bond fund, anyway? Some of those tickers you have look like news headlines from 10 years ago…because they were in the news 10 years ago. That’s why you bought them, right?

Portfolio management software is a tool, plain and simple

Portfolio clutter is a major problem. It’s far too easy to ignore that one giant stock that towers over your holdings. It has appreciated so fantastically (and pays a dividend!) that you ignore the risk. We load up on assets that achieve roughly the same ends, and confuse owning a number of assets with real diversification.

Behavioral economists refer to this as the “endowment effect.” Scientists have puzzled over why we tend to become attached to things, even things we know to be neither beautiful nor useful. Chimps fall victim to it. We seem to be hardwired for this odd reluctance to part with things once we have them. Problem is, along with a load of other irrational behaviors, such as bandwagon thinking and confirmation bias, the result is that we are quite naturally very bad at building effective investment portfolios. We get attached.

Portfolio management software, just like those tax websites, addresses that weakness directly. As Bill Gates once put it, “Software is magic.” And he’s right. In those thousands upon thousand of lines of code, every conceivable angle is figured and considered. Buys and sells are not “brainless” but, rather, the result of many hundreds of hours of real human brain cycles, coalesced into a very usable tool.

Is portfolio management software perfect? No. But it certainly avoids the all-too-human problems of holding stocks for their sentimentality, of guessing wrong and losing big, and of trying to outsmart literally millions of other people at once.