The Psychology of Investing
If families who were wealthy in the US or Australia in 1900 would simply have invested in a broad number of shares of their market and done nothing else, they would now be tremendously wealthy. Before tax their wealth would have doubled roughly every 10 years or by a factor of 2,000 in 110 years. A tremendous reward for pretty much doing nothing.
Clearly no family has been able to do this. The reason is that doing nothing is HARD.
The mechanics of accumulating wealth are simple - spend less than you earn and invest the difference well.
For most people both of the above parts are difficult. Here we comment on the second part:
investing the difference well.
There is a whole branch of economics called behavioural finance that concerns itself with the interaction of psychology and investing.
A report by Dalbar, Inc, an American research company, puts it this way:
"Investment return is far more dependent on investor behaviour than on fund performance. Mutual fund (investment fund) investors who hold their investments are more successful than those that time the market."
QAIB (a branch of Dalbar, Inc) applies the principles of behavioural finance to provide measurements and insights into what mutual fund investors really do, what is in their best interest and what it costs them.
Their table (below) shows a list of the most common mental errors investors make.
Principles of Behavioural Finance
Financial Advisor Role
The financial planner can at times be at their most valuable when they recommend to do nothing – at other times it is very important to take action but surprisingly often the best course of action is to do nothing – it avoids all the mistakes listed above.
The following quote taken from Peter Stanyer in "Guide to Investment Strategy", and published by The Economist, gives in our experience one of the most important examples – of the role of a financial planner.
"Remember that good advice is valuable, and when the going gets tough, simple hand-holding by an adviser which prevents short-term mistakes may be the most valuable service that the adviser provides."
The mechanics of accumulating wealth are simple - spend less than you earn and invest the difference well