Can you be a Better Investor…?
Winning the losers game – Can you be a better investor?
In the wise words of Charlie Munger ‘Warren Buffet and I aren’t smarter than anyone else, we’re just less stupid than they are’.
What the king of great investment quotes means here is that investing is not about how smart you are, it’s about limiting the mistakes you make. In fact, Mr Buffet himself said ‘ an IQ over 125 is wasted in the stock market.’
In the book entitled ‘Winning the losers game’ Charlie Ellis (founder of Greenwhich Associates, board of Yale endowment & on the board at Vanguard) likened investing to playing sports.
The very best, the 0.1% professionals play the game the game to win. Let’s take tennis for example. Roger Federer could hit almost any shot to win a point. Whether it’s an amazing serve, a canny drop shot or his beautiful forehand, as one of the greatest to ever play the game, he could affect the game by winning points. When I play tennis, I lose generally because I’m double faulting, hitting the net or hitting the ball far beyond the lines….. I am making mistakes because I’m an amateur.
This is the same when I play golf, it’s less frantic and I should therefore be able to be more strategic on the golf course. However, my emotions often take over, why take a safe 3 wood off the tee when I love hitting my driver and the feeling of bombing one down the middle. I know that my driver works 50-60% of the time and yet I still bring it out with me……
This is the same with investing and money is far more emotional than golf…… I always find it counter intuitive when I tell very successful people that doing nothing is the best thing for their portfolio. It’s only after they’ve have done well in the markets that this message really gets through.
Each year Morningstar release their ‘Mind the Gap’ study, which compares the returns generated by funds to the returns of the investors in those funds.
If an investor managed to generate a higher return than the fund they invested in, that shows they were good at timing their purchases and sales – they bought low and sold high. If an investor underperformed the fund they invested in, that shows the opposite – they invested their cash when the fund was at a high point, and sold after it fell.
Here’s a selection of their findings:
Investors received a shortfall of about 1.7 percentage points less than the total returns their investments in mutual funds and ETFs over the 10 years ended Dec. 31, 2021. This shortfall, or gap, stems from poorly timed purchases and sales of fund shares, which cost investors nearly one sixth the return they would have earned if they had simply bought and held.
Investors can improve their results by holding a small number of widely diversified funds, automating routine tasks like rebalancing, avoiding narrower or highly volatile funds, and embracing techniques that put investing on autopilot, such as dollar-cost averaging.
The 1.7 percentage-point gap between investor returns and total returns is more or less in line with the gaps found for the four previous rolling 10-year periods.
Investors in allocation funds, which combine stocks, bonds, and other asset classes, continued to show the smallest gap of any category group.
On the flip side, investors have struggled to use sector, nontraditional equity funds, and international equity funds successfully; these three category groups all experienced wider-than-average return gaps.
The more volatile a fund, the more trouble investors tended to have capturing its full return. Funds with higher levels of volatility generally experienced wider return gaps.
Investors in sector equity funds also fared poorly, as their weighted returns lagged the funds’ reported total returns by about 4 percentage points per year over the 10 years ended Dec. 31, 2020. Specialized funds were doubly disappointing. Not only did their total returns lag those of diversified U.S. equity funds by a wide margin to begin with, but investors also failed to capture the full benefit of those lower returns.
So, to conclude, the evidence is clear that DIY investors do under perform the funds they are invested in. Yes, this is as mad as it sounds. This under performance is caused by all sorts of reasons, for example a lack of diversification, fees, overtrading, timing issues, behavioural biases etc…
This under performance is used by people like me to demonstrate where a good adviser helps add value. There are of course many many many many (you get the point) ways we add value, but minimising client mistakes is certainly one of them. Obviously, most people don’t believe that they will be subject to these mistakes, hence we like to show and rely on the data, as opposed to people’s views.
It’s like saying most people believe they are an above average driver.
People never mean to make investment mistakes and hindsight is twenty twenty but humans and emotions will always have difficulty around money. So long live the good adviser (from a biased but good adviser).