You can be your own worst enemy
Caring too much about your shares instead of leaving them alone can be costly,
When you think about the things that might send your investments off course, you might picture a sharemarket collapse, or losing your job and being forced to sell at the wrong time.
But in reality, you are yourself the thing most likely to get in the way of achieving the best possible investment outcomes.
Research shows investors are their own worst enemies. They buy when prices are high and other people are excited about an investment, sell when prices are low and people are scared, and forget the reasons why they invested in the first place.
Morningstar data shows that international equity funds, which invest in shares across a range of companies, have had an average return of 8.77 per cent per year over the past 10 years. But the average investor in those funds only had a return of 5.76 per cent.
In bond funds, something similar happened. The average fund return was 5.49 per cent but investors only pulled in 3.15 per cent.
Morningstar said the more volatility a fund had, the wider the ‘‘behaviour gap’’ between what the fund returned and what investors made.
Why? Experts say investors make too many transactions and pick the wrong time to move their money.
It sounds counter-intuitive, but the problem may be that individual investors care too much about their money.
They see a downturn and their investment balance drop, get scared and sell – missing the investment gains that were just around the corner.
Financial Markets Authority director of external communications and investor capability Paul Gregory said individual investors were often driven by their emotions and fears. Often they were not aware of those drivers so did not have a chance to prevent them from having an effect.
An FMA report said people tended to value what was happening immediately over what might happen in the future, were overconfident in their own abilities and were unrealistically optimistic.
Gregory said people were hardwired to fear losses, so they were prone to pulling out of investments at just the wrong time.
Cristiano Bellavitis, a lecturer of innovation and entrepreneurship at the University of Auckland Business School said timing was negative for two reasons.
‘‘Although investors think that they can time the market, and eventually buy low and sell high, most of the them end up doing the opposite. It is not easy to hold on to a market that goes down rapidly and investors are tricked by emotions and prefer to get out,’’ he said.
‘‘When the market goes down, investors move into cash holdings, and when the market goes up they invest. Second, retail investors tend to buy assets that go up in price because they make them feel good, and sell stocks that go down in price.
‘‘These two phenomena are obviously detrimental to performance.’’
So what can you do? Gregory said the most important thing was to have a plan, and to stick to it. That plan would then guide an investor on what assets they should be invested in to achieve their goals, and how much they needed to invest to get there.
Investors should understand where their money was, what the risks were and how the investment was likely to behave. Then, they should leave it alone.
A study conducted by Woodford Asset Management, analysing return data from 1985 to 2016 in the UK market, showed the probability of capital loss decreases with time.
If investors stay in the market for one single day, they incur a 44.6 per cent risk to lose their money, but this risk goes down to 37.1 per cent if they are invested for one month, to 23.6 per cent if they are invested for one year, and to just 1.2 per cent if they are in the market for ten consecutive years.
‘‘If you invested in the S&P 500 the day of the peak on the 12th of October 2007, in six months you would have lost 56 per cent of your capital, and here is where many investors exited the market,’’ Bellavitis said.
‘‘However, if you kept your holdings for two years, your loss would shrink to 35 per cent, and if you kept your investments for ten years, you would end up with a capital gain of 54 per cent on top of dividends.’’
People should get enough information about their investments, either from their own research or from an adviser, so that they would not be surprised by a downturn happening, he said, or how big it was.
‘‘You should still feel like you are on course. Investing is not a 100m sprint from A to B. It’s a round-the-world yacht race, with a whole lot of tacking. If that’s what you want to do, it comes with the territory.’’
Investing for the long term would also encourage people to do more due diligence, Bellavitis said, and think carefully about the stocks they bought.
Richard James, chief executive of NZ Funds, said the best advice for investors was ‘‘don’t look’’. People should have a long timeframe and avoid transacting regularly, he said.
Making lots of investment transactions increases your risk of pulling out at the wrong time and also adds costs. Bellavitis said trading often meant more trading fees and potential capital gains tax.
‘‘The more decisions an investor makes, the worse decisions they make,’’ James said. ‘‘We are all hardwired to buy high and sell low. That’s the simplest thing someone can do, is limit the extent to which they make irrational decisions.’’
He said there was no reason why they could not have the same outcomes as fund managers, provided they exercised discipline to overcome behavioural biases and could stick out market volatility.
‘‘The more decisions an investor makes, the worse decisions they make. We are all hardwired to buy high and sell low.’’ Richard James of NZ Funds