Last month we wrote about the five things a person needs to do to be fiscally successful. This month we just want to highlight one of those aspects and its seminal importance to an investor’s positive outcome.
By way of introduction, we point out an interesting fact; the 2002 Nobel Prize in Economics wasn’t awarded to a finance genius or world economist. Instead, it was won by a psychologist (Dr. Daniel Kanneman). His claim to fame? He and colleague Amos Tversky applied psychological insights to economic theory. Specially, they tested whether people were really logical in their economic decision making. Particularly they measured whether people were rational in their judgment under conditions of uncertainly. They found— they weren’t.
Our emotions and automatic reactions (from adrenaline, etc.) have been under development for at least 8,000-10,000 years. Juxtaposed against this lengthy history, we have organized stock and bond markets that are only 100-200 years old. Combine the two and you’re mixing apples and oranges. These differences are why people state in rising markets “I can accept a lot of risk” (Bring it on baby), whereas the same person in declining markets says “I don’t want any risk!”. It’s illogical, and people know it’s not rational, but they still repeat the same mistakes time and time again.
The above reasons are likely the prime ingredient leading to a troublesome observation that has been tested and measured every year for over 20 years. Known as the DALBAR study, it measures the performance results of funds compared to the results the average investor in those same funds received. They find the average (say large cap) fund earned 7-9% per annum, whereas the average investor in those exact same funds earned 2-4%[i]. How can this be? Well, if you panic and sell out when things go down (‘everyone around me is doing it’) and (with regret / remorse) go back in when the markets get up again, you get killed. You end up with a result that probably doesn’t even keep you ahead of inflation (after taxes) and literally sacrifices what could have been a confident and peaceful financial future.
As Harry Truman quoted: ‘If I want to be great I have to win the victory over myself… self-discipline.”
At Wellspring, you are positioned to outperform the majority of investors. That’s great and why we got into this industry. However, the key is not the great investments, it’s the discipline and wisdom to do the right thing even when it seems counterintuitive.
The above is HARD to do, but smart. Thanks for letting me both position and assist you to be smart and successful investors.
[i] Over a 20-year period, the average equity investor
has earned 3.83% per year, far less than the 9.14% return
of the S&P 500 (TGS Financial, Fall 2011 Navigator).
