I have been helping clients make investment decisions for over 25 years and it never ceases to amaze me how the adage of “plus ça change, plus c’est la même chose” still applies – the more things change, the more things stay the same.
In all this time I have experienced the investment stresses of the USA’s Savings and Loans crisis of the late 1980s, Black Monday in 1987, the Russian Financial Crisis in 1998 followed closely by the Long Term Credit Management collapse, the Technology Bubble bursting at the start of this Millenium and for good measure 2 Iraqi wars and an ongoing war in Afghanistan.
Add in the unfortunate experience of the Japanese Tsunami and the Libyian crisis, not to mention the Eurozone bailout problems, and one could be forgiven for thinking that one should never invest. There is too much uncertainty in the world!
Well guess what, there always was and always will be!
Going back to the Black Monday Crash in 1987 one might remember, if you are old enough, that the Dow Jones Index fell by 22% alone on that day to close at 1,738.74 only to recover the total losses within 18 months. As at Friday 8 April 2011, the Dow Jones index stood at 12,380.05, an annual compound gain of 8.4%. A tremendous gain especially when you consider that the Dow Jones reached 14,156 in October 2007 before falling to 6,626 in March 2009 and then recovering to current levels.
The moral of recognising such volatility is that no-one can predict the markets – there is no crystal ball! Yet despite this, investor behaviour, both individually and collectively has not changed and investors continue to lose substantial monies by continuously committing the six deadly signs of investing. These are:
- Being Overconfident. Investors thinking that they can outthink the market. They never can and never do. Otherwise everyone would be rich.
- Having an Hindsight Bias. It’s easy to see patterns in hindsight, therefore you can predict the future. Wrong! The global investment management industry is populated by some of the smartest people ever to live and yet they cannot see patterns. If they could invent a see through process then nobody would make money as there would be no risk premium available in markets to take advantage of.
- Having a Familiarity Bias. By concentrating investment in a few well known stocks or assets gives some investors a sense of being in control and therefore comfort. I wonder how much comfort investors in Irish banks now feel post Celtic Tiger?
- Regret Avoidance. “I won’t make that mistake again” or “It’ll be different this time” Short term investment is no different than placing a single bet on a particular number on a roulette wheel. It becomes speculation and in chasing a stock gain, heavy losses usually follow.
- Self Attribution Bias. If an investor is fortunate enough to make a gain, there is a tendancy to take the credit as being their skill in stock picking. If a loss is incurred, then it wasn’t their fault, it’s the market’s and everybody got caught out!
- Extrapolation. Why do investment companies attach wealth warnings that past performance is no guide to future performances. It’s because they know that investors chase markets after the fact. They get in after markets rise considerably only to see them fall considerably, then exit when they fall considerably only to see them rise.
And what is the answer then? Simple. Stay invested in a well diversified portfolio consistent with your risk tolerance once you have enough cash for current and emergency expenses. 8.4% p.a. over a 23 and a half year period didn’t happen by stockpicking. It happened as a natural consequence of markets doing what they do. Time, not timing, is King!