Millennia of evolution has ingrained in us many psychological traits that has served us well as a species, but that works against us when investing. Some of these traits are;
- Herding. Copying the behaviour of others even in the face of unfavourable outcomes.
- Loss Aversion. Expecting to find high returns with low risk.
- Chasing past returns and anchored views. Investors typically focus on the best investments and investment managers over the last five years or less, which can lead some to invest in expensive assets with lower expected returns than cheaper out of favour investments.
- Narrow Framing. Making decisions without considering all implications.
So how badly have average investors fared compared to the markets?
Many of our clients are familiar with DALBAR’s annual Quantitative Analysis of Investor Behaviour (QAIB) study, where DALBAR analysed cash flows in and out of mutual funds to calculate investor’s average net investment returns. The latest report covers the period from Jan 1st ‘1985 to Dec 31st 2014 and paints a similar picture to earlier studies. Here are the key findings:
- Over the period the S&P500 returned 11.6% pa, the Barclays Aggregate Bond Index Returned 7.36%pa, and inflation was 2.70%pa.
- Equity investors achieved 3.79% per annum on average, barely ahead of inflation.
- Fixed Income investors achieved 0.72%, almost 2% behind inflation.
- Costs and poor management contributed to the underperformance, but poor decision making was likely the primary detractor from average investor returns.
The results are a valuable reminder that trying to predict the future can have an overwhelmingly negative effect on investors’ investment experience, and that identifying the right asset allocation and sticking to it may provide the highest odds for a favourable outcome.
Warren Buffet probably summarized this the best when he said; “Investing is simple, but not easy.”