Know Your Greatest Enemy
After a quarter of a century in private client wealth management , there is one thing that I am more certain of than ever – the private investor ’ s greatest enemy is that person that looks back at you when you brush your teeth or comb your hair in the morning . Your own behaviour has a far bigger impact on your financial destiny than any comment by a politician , any policy decision by a central banker , any change in the economic growth rate , or the investment market ’ s rollercoaster behaviour .
Theo Vorster
Most , if not all investors , are susceptible to emotions , because they are human , and at times they may be prone to fear and greed . When markets are down and after taking a hit , they are tempted to sell at a loss , or reluctant to invest in good value . That is fear . And after a good run in the markets , they are tempted to invest more , sometimes in much overvalued stocks or “ bubbles ”. That is greed .
Emotion is great when it comes to selecting a bottle of wine , choosing a meal , or investing in a holiday , but not so much when it comes to personal financial planning and the pursuit of long-term goals .
Many studies , especially in the United States , have investigated the cost of emotions , the penalty that investors pay for their behaviour . Research firm Dalbar , for example , performs a quantitative study every year of the damage to investment performance due to behaviour .
The latest study again shows that the penalty is huge .
The average balanced investment portfolio has achieved an annual return of around 6 % over the last twenty years . This means that an initial investment of $ 1 000 would have grown to around $ 3 200 over the period . However , the average investor who invested in these funds only achieved 2.5 % per annum over the two decades , which means that an initial investment of $ 1 000 only grew to around $ 1 600 , half of what the average portfolio delivered . The biggest reason ? The behaviour of investors : selling after a period of bad performance and investing after a period of good performance .
And , if you believe , like most of us , that you are too clever to buy into a bubble or sell at the wrong time , be reminded that when your emotions pick a fight with rational behaviour , emotion is going to win almost every time .
Take Sir Isaac Newton as an example . One of the smartest people in history . The final week of April 1720 was a good one for Newton in the investment markets . He had invested money in the South Sea Company in February of that year , which he sold in April , making a small fortune of £ 7 000 ( about R20 million today ). By way of background : this British firm was founded in 1711 and received a monopoly from the government to trade with South America . It was not long before rumours of extraordinary riches to be made did the rounds , and there was euphoria around the company and the value of its stock . By selling out in April , arguably a rational investment decision , Newton became quite rich . The story did not end here . The stock kept on climbing , defying gravity . And Newton got sucked back in and invested again . This time – in June 1720 – he was all in .
Emotion drove this decision : he did not want to miss out
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