Most of us invest in the stock market and or bond market either through our superannuation (industry fund or SMSF) or directly. When it comes to how well those investments do and how much money they make you, have you ever wondered which is most important: a) where the money has been invested or b) how the investor behaves?
The seemingly obvious answer is that it is where the money has been invested but it is actually the investor’s behaviour. Yes, the investor has a bigger influence than the markets and in most cases the investor’s influence reduces the potential money to be made from the investments.
This very unintuitive phenomenon has been extensively researched by a company called Dalbar which provides an (expensive) detailed annual report on the phenomenon. The latest report shows some interesting statistics – they are for the US market but they apply just as much in Australia:
The US share market has grown by ten percent a year over the last 30 years (yes, really despite all the downturns) but managed funds that invest in equities (and our super funds invest in some of them) have only returned four percent and that is before fees and tax. An investor who would have just duplicated the index would be more than five times as wealthy after 30 years. Ten percent vs 4 percent compounding over 30 years makes a big difference.
The same is true for bonds, which are much less volatile and our super funds also invest in them. Here the numbers are 6.3 per cent for the market and 0.6 per cent for the investor.
How do these massive discrepancies in investment returns happen?
The answer is psychological. Investors have a strong tendency to invest in funds that have done well. The problem is that these funds often have mediocre or worse performance once many people have added their money and there are a lot of reasons for that – chief among them being that a big part of a fund’s performance is due to chance and much less often due to skill.
Another big reason is that investors chop and change and each change opens up a lot of potential for things to go wrong. Hence one of the most important points for an investor is to start out right and then realise they get paid for holding their nerve and to do … nothing, in the large majority of cases. That is much more difficult than it sounds and is one of the unsung ways advisers can help their clients do well with their investments.