Humans are their own worst enemy when it comes to investing
September 3, 2015
Your investments will perform poorly. They always have and they always will.
The common ingredient for many investors is to predict the future. The idea is to understand what will happen and then invest accordingly and have investment success.
Today we offer our own prediction. You will fail. To be more precise you will fail by a lot.
Your investment results over the coming years will be significantly less than if you had just blindly purchased a diversified portfolio and held it for the long term.
There are many different sources of evidence that support the fact that humans are very poor investors. Studies show that individual investor performance is significantly less than results for the markets they invest in.
This is true in Canada and it is true in the United States. The common denominator is the individual investor.
How can this be possible? If you invest in equities and those stocks increase in value over time then how is it possible that you do not participate fully in those increases?
Identifying the problem is as simple as looking in the mirror. You are the problem and our prediction is you will continue to be the problem.
Individual investors are their own worst enemy. They invest logically for the long term and then emotionally change their mind in the short term.
People buy high after the markets have appreciated in value when they are confident and sell after their investments have declined in value because of a market downturn. That is exactly opposite to what we all know, which is by low and sell high.
Better still we believe strongly in a buy-and-hold strategy. Research proves this works best time after time.
One of my favourite sources of information on how poorly investors manage their own portfolios was data provided by one of the largest mutual fund companies in the United States. We used this information in one of our previous columns.
The company looked at the investment results from orphan accounts. These are accounts where investors had moved and not changed their address so the regular investment statements were returned.
The significance is the investors had forgotten about their investment and therefore were not doing the normal human thing which is over-managing their accounts. They did not attempt to time the market like most people.
The investment results for those orphan accounts were better than for all others. The conclusion is that over time investments do fine and when investors are actively involved the results suffer.
Philip Zimbardo who is the co-author of the book Time Paradox has an interesting perspective. He said that our world has changed dramatically in the past 150 years and by contrast it took millions of years for humans to evolve and we have not changed very much in the past 150,000 years.
That is a polite way of saying that we humans have passed our best before date. Our world has changed but we have not.
There are two contrasting ways to invest. The first is to invest according to the evidence and to maintain a disciplined approach. The other way is to invest like a human.
We believe there is a lot of evolution to be done for investors and in the meantime we should try and protect ourselves from ourselves.
Our recommendation is to follow an evidence-based approach to investing: Invest for the long term and be disciplined.