Human beings are social animals with 70 to 80% of our waking hours spent in some form of communication. On average we are speaking 30% of the time but we do significantly more listening at 45% of the time. So, more than half our waking hours are spent taking our cues from our environment, especially other people, on how to act. Humans have survived and prospered because of our ability to band together but this adaptive behaviour has hard-wired our brains to be consistently awful investors. Harsh? Check out the data.
The results of research done by Dalbar Inc, a company which studies investor behaviour and analyzes investor market returns has consistently highlighted below-average returns for the average investor. For example, the 20 year period to 2015 saw the S&P 500 deliver an attractive 9.85% per year. However, the average investor missed out on almost half those returns with an annualised performance of just 5.19%. Before we reveal the reason behind this debacle here’s another data point which might give the reader a clue. Fidelity, the giant fund management company, conducted a study a few years ago of its highest-performing individual investor accounts. The report when published attracted quite a bit of publicity when the star performers weren’t exactly market experts or algo-savvy wizards. The galling reality for Fidelity and thousands of embarrassed wealth advisors was that the top-performing account holders had either died or totally forgotten they had an account!
The problem for the average investor is that our psychological DNA leads to illogical investment decisions based on emotional reactions to the short term good or bad news flow generated by the crowd and its media channels. We eschew our normal retailing discipline and insist on buying goods/funds when prices are flying high and then returning goods/funds at ‘on sale” prices rather than original purchase prices. No wonder Warren Buffett wrote in his annual letter in 1986, “Inactivity strikes us as intelligent behaviour.” On the subject of Buffett, there have been libraries of literature on his investment process but perhaps his greatest business initiative was to consistently educate his investors as to the value of time and a long term perspective. Sadly, this logical use of time and the miracle of compounding income is absent in the majority of investor pools. Additional research by Dalbar Inc shows that the average holding period for supposedly long-term investment fund products is just less than 4 years. This week’s events will no doubt add to those damning statistics.
As financial headlines scream Trade wars (China), Trump wars (Iran) and Tech wars (Facebook) markets have had a volatile week yet many will resist the logic of doing absolutely nothing. Apart from counsel from a professional advisor, a little bit of long term perspective can prevent our hard-wired urge to “fit in” and join the reactive emotional crowd. Think about all that trading, emotional activity and then consider that the S&P 500 in the 93 years since 1927 has had just 11 years where markets were down by more than 10%. Those scary headlines this week didn’t mention the 68 positive years experienced by the S&P 500 but that doesn’t capture eyeballs or generate commissions. In some ways, technology and ease of execution have exacerbated the problem, allowing investors to react quickly and emotionally to the prevailing mood of the market place. One does wonder whether one day we will have fund products which demand long-term commitment? It doesn’t look like a commercial winner but maybe there are more subtle offerings out there.
If one looked for an investment proposition which required a long term capital commitment and contained some volatility comfort then an EIIS scheme could tick those boxes. It’s a 3-4 year commitment and a 40% tax saving provides a significant valuation comfort. For context, there have been just 3 years out of 93 years where the S&P 500 lost more than 30%. Funding start-ups, of course, has its own risks but the discipline of long term investing could, in its own right, be a diversification of behavioural risk. And for those still sticking to their social DNA requirements, there is a great opportunity via equity crowdfunding platforms to seek out EIIS opportunities and the less emotional wisdom of crowds!
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