Beware! An investors enemy is likely to be himself........
Watch your (Investor) Behaviour…..
Given the recent volatility in markets I thought it may be useful to address a key truth in investing - an investors enemy is likely to be himself/herself. What I mean by this is that very often investors are swayed into making snap investment decisions based solely on recent market movements. This is because we, as humans, often act emotionally rather than rationally. After all no-one wants to appear to be a fool and be left holding an asset that is apparently crashing to zero worth. However acting emotionally is usually detrimental to one's financial health.
An investor, whether it be through a pension or investment bond, should think like a business owner, not a temporary employee. Most business owners don't get up in the morning and ask whether they should sell their business that day. If they own a pub, they don't think about whether they should really own a shoe shop instead. They show patience and persistence and try to understand their underlying business better so they can earn the greatest return for the longest period of time. Similarly investors should ensure that they understand their investment strategy, and be confident that it is robust and adequate to achieve their investment goals and is within their tolerance and capacity for investment risk, and once it is, they should be comfortable with the ups and downs that any investment experience will bring. There is a need to align investment goals with the need for long term outcomes rather than seeking out short term comfort.
When stock market falls sharply, there is a tendency for people to make changes to their investment strategy without due consideration. Investors are misled by stock-market volatility and are done a dis-service by the short term noise many media outlets, financial journalists (and some financial advisers) create. This noise encourages people make emotional rather than rational decisions about investments.
A regular finding of an annual study on investor behaviour - the Dalbar Quantitative Analysis of Investor Behaviour (QAIB) shows that the average equity fund investor consistently underperforms the benchmark by a large margin.. Why?
What tends to happen is that in falling markets, the average equity investor rushes to ‘safety’ (ie cash) and therefore crystallises a loss. When stability returns to the market, they buy back in (at the now higher price). This buy high / sell low runs contrary to the heart of investing, - buy low / sell high.
It is important to realise that investing in the stock market will not provide you with steady consistent returns
. The market is by its very nature volatile. The graph below is based on the historical returns in the period from 1928 - 2018 of the S&P 500, which incorporates the 500 largest companies in the US. The average annual return of the index over that period is 11.36%
. However I have plotted this average figure (orange dots) against the actual yearly returns (blue dots), and you should note that rarely the average and the actual return coincide. In most years the index's return was outside the average, often by a large margin and with no obvious pattern. For investors, this data highlights the importance of looking beyond average returns and being aware of the range of potential outcomes. *As an aside, theoretically, had you invested $100 in the S&P 500 in 1928, the current value of the investment would be worth a whopping $382,371 - the wonders of compound interest...
* Note indices are not available for direct investment, therefore their performance does not reflect the expenses associated with the management of an actual portfolio.
I believe that understanding this research, and acknowledging that we, as humans are emotional, and are subject to certain biases, is helpful when formulating an investment strategy or making investment decisions. By understanding and improving our investment behaviour, we improve the possibility of more favourable outcomes when making investment decisions. An effective and reliable and knowledgeable financial adviser should help to keep the emotion out of investment decisions, and always remember that no matter how unattached to your investment you think you remember that investing is never, ever, a theoretical exercise; you're never as detached from portfolio losses as you think you will be.
I hope you find this communication informative and interesting and if you feel that I may be able to assist you in any way in relation to insurance, pensions, investing or tax, please drop me a line. I will be happy to help.
Gavin Gilmore QFA FLIA CFP, TEP, CTA (Chartered Tax Adviser)