STREET DOGS

STUDIES of investor behaviour tell us some surprising things about the decisions they make … 85% of sell or exchange decisions are wrong — the investor would do better by doing nothing or going the other way that 85% of the time. Random decision making (no investment knowledge) would have yielded about 50% good decisions.

In the 20 years ended 2008, a great period for stocks, the average investor averaged a 1.9% annual return whereas the average mutual fund returned 8.4%. With compounding, the difference was about ninefold (402% vs 46%) over 20 years.

Investors are not particularly stupid or ignorant, but they make stupid investment decisions with horrible consequences. How to explain this?

The economist and investor John Maynard Keynes emphasised that individual investment profits are largely determined by how investors behave at market tops and bottoms — which is where price volatility concentrates, where sudden spikes occur, where the big investment mistakes are made.

The huge losses from buying into popular asset manias near the top at high prices (with no safety margin in case of a decline) and the lost opportunities from selling temporarily unpopular but cheap assets at or near a bottom devastate long-term results because of the powerful effect of compounding, which multiplies the effect of large errors.

Moreover, investors who suffer these losses are generally hurt psychologically and are often too gunshy for months or years afterwards to pursue even sensible opportunities. What’s more, such losses typically demoralise the savings discipline of most losing investors, making it harder still to fully take advantage of future opportunities. —