If you aren’t happy with the growth on your investments, be assured that you are not alone! The majority of investors worldwide achieve poor returns on their investments and retirement savings.
Numerous studies show that the returns that investors have achieved over time are much lower than the returns of the average investment. This holds true in all countries, and over many decades. Studies in the USA have revealed that since the 1974 establishment of the personal Retirement Annuity (called a 401k account), the US stock market has grown at over 11% per annum. Over this same period, the average investor earned less than 4% per annum. Allowing for different returns from the asset classes typical of a balanced retirement portfolio, the average investor here received only half of the returns that they should have benefited from.
Investors receive only a fraction of the returns that they could
This sounds crazy, but the good news is that if we take the time to understand why this happens, we can approach investing in a more systematic manner, and then achieve consistently better investment returns.
Conventional financial theory suggests that investors are rational and seek to maximize their wealth through objective, non-emotional investment decisions. That makes sense. Nobody invests with the goal of losing money. However, the emotions of fear and greed, along with the herd instinct, can override rational thought. Behavioural finance is a relatively new field that seeks to combine psychological theory with conventional economics to provide explanations for why people make irrational financial decisions.
You don’t need to beat the market – just don’t let the market neat you
Successful investors tend to take a longer-term view, select reputable fund managers and avoid switching between managers to the fund of the moment. They stick with their manager and ride out the market cycles. But most investors don’t do that. Instead, they move their money in and out of their funds in the hope of gaining better returns – and because their timing is often bad, the result is long term poor performance.
Why do we do it?
This “behaviour gap” is driven by several well understood cognitive errors. Human nature shows that we have evolved to avoid pain and to pursue pleasure and security. It feels right to sell when everyone around us is scared (we tend to sell at the bottom of the market when it is cheaper) and to buy when everyone feels great (we often buy at the top of the market when it is expensive). It may feel right – but it is not rational. What many investors may not realise, is just how difficult it is to then make up that loss. For example, a 50% loss would require a 100% gain just to break even—a concept known as negative compounding.
Better investment returns for the average investor can be achieved by:
- Defining your own realistic and clear investment goals.
- Understanding your risk profile, and the potential returns and volatility that can reasonably be expected from that assumed risk.
- Investing in a strongly diversified fund with reputable asset managers who have good track records.
- Stay the course and adopt a long-term investment approach.
Markets are beyond our control, but knowing how we are going to behave in any market environment is essential to long-term investing success
Investing your own money is a very difficult thing to do. To invest properly, you need to emotionally detach yourself from your money which is not easy. How markets are going to behave is beyond our control, but knowing how we are going to behave in any market environment is essential to long term investing success. Partnering with a trusted Financial Advisor will enable you to remain objective and neutral.