Time Not Timing Is The Real Issue. The Behaviour Gap Impact.

It’s amazing. Some years ago it was considered normal if you talked at dinner parties or in the pub about what you invested in and how much wealth you had as a result. With the Celtic Tiger bust, this had become a topic that was taboo. Nevertheless with stockmarkets hitting all time highs in recent weeks the discussion of wealth has hit centre stage again not only in Ireland but also in global financial media columns.

Another interesting issue that is being commented upon internationally is the fact that any investor who adopted a buy and hold strategy in most low-cost index funds of a developed market has not lost money. This is a little odd when you consider that we have had the tech bubble in the early noughties, followed by the 9/11 market reaction and then in recent years the global financial crisis.

Ironically while the statistics show the academic scores in a good light very few investors have seen the real growth since most have adopted a sell and buyback in the light of market volatility in recent years.The leading US analytics firm Dalbar continues to gather data on how collective funds and individual investors performed over the intervening period. Irrespective of asset class of either bonds or equities, personal investors lost 5% p.a. against index funds that had an implicit buy and hold philosophy. This strategy is nothing fancy as index funds move up and down with the underling markets they track. As long as entry and annual costs are kept low, investors have a far better chance of quickly making up the relative investment costs.

All that is needed is for investors to be long term holders of investment positions. But generally they’re not. Unlike an index that is blind to emotions, most investors do not have either the patience or the nerve to hold their market position. Greed or fear drives them to sell out at low prices and buy back in at a higher price. Sometimes this happens because investors are overconfident in their ability to beat the market and sometimes it is because they are genuinely afraid that their life savings will be decimated.

This difference between returns generated by the markets and returns effectively generated by investors themselves is well known and is referred to as the “Behaviour Gap”. Apart from Dalbar, leading financial academics have been writing papers on the subject for decades. One such academic Meir Statman of Santa Clara University in California estimated that 93.6% of investment return, for good or bad, was down to the behavioural decisions of the investor. If an investor decided to stay with the markets, through good times and otherwise, they reaped the rewards. If they decided to exit, they lost out mainly because they made poor judgements about when they got out and then came back in again.

Most investors are unaware of the cyclical nature of markets despite the proliferation of information through news channels, the internet and the printed media.  But being part of a roller coaster is no fun if you feel like getting sick on every steep decline whether you are on the real thing or just watching your investment values gyrate. For example since 1928, there has been 20 periods of a 20% or greater decline. Despite this, the US market increased nearly 100-fold during this period. If the impact of dividends was added back this resulted in a 140-fold with dividends and inflation factored in. Rebalancing of returns, over time, is a necessary element of investor strategy otherwise short term returns might get wiped out by short term losses by what is referred to as regression to the norm in statistical terms.

Even allowing for major geopolitical events a separate yet serious market fall happens once every 10 years and when it happens it can be savage. While nobody has the lifespan to oversee  a period of 80 years financial history has shown that market volatility is not a recent contagion. It’s been there all along. Nonetheless, volatility is part and parcel of the investment gain. It draws investors in and for those unsure of themselves it spits them out.

But for those who decide to stay on the ride and in control of their emotions, it brings eventual gains and in some cases these gains are very substantial. Warren Buffet says it best “Be fearful when others are greedy and greedy when others are fearful”. And he should know as he has been around longer than most. The Russian novelist Tolstoy was a little bit more gentle when he expressed “The two most powerful warriors are patience and time.”

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