Looking at share market returns over time, it can be said despite volatility that is naturally experienced, investors are rewarded for their patience and discipline with growth over the long term. However, plenty of research indicates that investors are not getting the returns they are entitled to.
In order to capture returns in the share market, investment time horizon does matter. Most investors intend to invest for the long term, however, emotions come into play which often leads to irrational decision making. The Dalbar Quantitative Analysis of Investor Behaviour releases annual reports comparing the returns of the market (in this case S&P 500) and the returns of an average equity investor. Over the 30 year period to December 2016, the S&P 500 returned 10.16% per annum while the average equity investor achieved a return of 3.98% per annum. That is a staggering difference of 6.18% which is referred to as the ‘Behaviour Gap’.
The behaviour gap is the outcome of all the biases and psychological pitfalls previously discussed, which is magnified by an oversupply of information and media coverage. It can be the result of a fearful withdrawal of funds from the market following a major political event or perhaps the overconfident additional investment in the market after reports of a year of very strong returns.
Essentially it is when our emotions are interfering with our disciplined approach. Perhaps the two emotions most likely to get in our way are fear and elation, despite being at opposite ends of the spectrum.
In falling markets, it is natural to feel fear and a sense of panic. How you act on those emotions is what will determine your investing outcomes. Option 1 is to succumb to the fear and sell your investments to try to avoid further loss. As a result, you have sold low and consolidated the loss rather than waiting out the market cycle. Option 2 is to embrace the opportunity presented and make additional investments to maximise the likely subsequent recovery of markets.
In rising markets, investors experience elation and excitement as they see the strong return for their investment. Again, how you act on your emotions determines the investment experience. Option 1 is to get carried away in the thrill and invest additional funds at the top of the market cycle. While markets may continue to rise for a while, buying at this high point can then maximise the loss when the market goes through a downturn in the next phase of the cycle. Option 2 is to sell some of your assets and consolidate the gains you have achieved. The profits can then be used to invest elsewhere.
Data shows that most investors in either scenario go with option 1. Data looking at investment performance and the flow of funds into and out of the market, shows that in rising markets there is a significant net flow of funds into the investments but when there are market downturns, money is flooding out. Meaning the average investor is reacting to current market conditions, selling low and buying high. This is what results in the behaviour gap and missing out on the returns that they should be achieving.
Source: Investment Company Institute, 2017 Investment Company Fact Book. Past performance is not a guarantee of future results. Data shows industry flows into equity funds plotted as a 6-month moving average. Total return based on the MSCI All Country World Daily Total Return Index, a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed and emerging markets.
Knowing when to buy and sell is a difficult process to manage and we don’t advocate trying to time the market. Rather, the key is to remain disciplined and not reactive while investing. An adviser can keep you accountable and help you remain on track when all your instincts are pointing towards making decisions which will sabotage your financial future. Often, the value in an adviser is quantified by the decisions they help you make and the progress towards goals. While this is important, I would place equal importance on the adviser’s role in preventing you from making the wrong decisions.
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