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Stay the course

Shani Jayamanne  |  24 Jun 2021Text size  Decrease  Increase  |  
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Benjamin Graham famously wrote in the Intelligent Investor that ‘the investor’s chief problem—and even his worst enemy—is likely to be himself’. What Graham meant by this is that humans are inherently emotional beings, and this often impacts our decision-making processes, especially with investing.

We see this happen when markets plunge. It causes anxiety and fear for many, and this can cause panic selling or investment switching. We saw this when investors were panic selling at the bottom of the market during the GFC. We also see this on the upside when markets run, the sense of elation that investors get when they see green in their investment accounts causes them to pile in money. We saw this right before the Tech bubble burst in 1999. We’re wired to avoid pain and pursue pleasure and security- that’s why it feels right to sell when everyone around us is scared and buy when everyone feels great. It may feel right, but it’s not a rational way to invest.

These decisions have been studied over years and there’s a pattern—there’s a gap between the returns that an investor gets, and what an investment model or benchmark gets. This is called the behaviour gap.

The behaviour gap looks at how investor behaviour can impact returns. Morningstar have been doing a study called ‘Mind the Gap’ since 2010, quantifying the impact.

The study looks at the returns from the average investor and the average fund returns—it compares the average dollar invested in a fund with the fund’s time weighted return—the gap between these two numbers represents the impact that the timing of investors purchases and sales had on the investment outcomes received.

There are a few insights from this study:

More volatile funds had larger gaps—the correlation makes sense—volatility, as we spoke about before, may entice investors on the upswing, but may cause fear which leads to redemptions during downturns.

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Another insight is generally, big pivot years for the markets lead to the worst timing. What this means is that investors sell after a bear market and buy after a bull market—even though one of the most well-known investing adages is buy low, sell high. We all know this, but in practice it’s very different when emotions come into play.

This played out during the GFC for US investors as mentioned, where the gap widened even further—we saw a lot of panic selling at the bottom, missing out on a dramatic rebound. The gap between investor return and investment return was 2% in equities-based funds and 1.44% in alternative funds.

In Australia, we have compulsory superannuation. This is a perfect example of drip feeding our retirement savings, often at a set frequency without withdrawals until retirement—so we’re forced to keep invested, in a way. This has resulted in an overall outperformance of 65 basis points versus total returns and strong investor returns for all asset classes.

The lesson we can derive from this is that when you take panic selling or emotional decisions out of the equation, investors tend to fair better.

Staying the course is not an easy feat. You are battling against primal emotions, and you are forcing yourself to make unnatural decisions.

Tackle the Behaviour Gap

Stay the course by first designing a course for your investing journey. Construct a portfolio with consideration of long-term goals.

Have reviews of your portfolio in regularly scheduled intervals (like quarterly, or half yearly), instead of constantly reviewing your portfolio. You can add a goal and connect it to your portfolio through the Portfolio Manager, allowing you to easily check your progress against your goals instead of the broader market. At the end of the day, what matters is your progress to your goal, and not beating a benchmark.

Create ‘speed bumps’ for yourself. Speed bumps are any measures taken to ensure that you do not over trade or make rash decisions regarding your investments. This could be requiring a second opinion to trade or setting a rule to sleep on a buy or sell decision. For long-term investors, the delay that this adds is usually negligible on returns if the decision is made to execute but will add rationality to their investment process that can prevent the behaviour gap.

is an investment specialist, Individual Investor, Morningstar Australia.

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