Behavioural FinanceI speak to a lot of investors that have previously managed their own portfolio. It is incredibly popular in the UK, as I imagine it is in other countries. We all fancy a dabble now and then, and picking investments probably doesn’t seem all that difficult.

I attended a presentation recently where a couple of statistics were used as an insight into the world of DIY investing and more importantly behavioural investing.

I should say at this point that if you are at all inclined to invest your own money then the first thing you should buy is a good book on behavioural investing, or get some low cost financial advice to begin with to set you on the right path. Understanding why people make the decisions they do is fascinating and will hopefully stop you making bad decisions.

Anyway, back to the stats:

  • 7000 DIY investors in Germany underperformed the normal market return by an average of 7.5%*.
  • The best performing fund in the US between 2000-2010 generated 18% per annum average return. The average return earned by an investor in that fund was -13%*.

We only ever buy funds or shares that have done well or that we have heard of because emotionally that makes us feel good and secure about the purchase. Enter problem number one, and the use of emotion in that sentence. Then, when things don’t go the way you expect them to, e.g. the fund does badly, the share price dips, the company stops paying a dividend etc. (remember BP, or own any Lloyds at the moment?) you emotionally sell funds or shares. I say emotionally with some confidence because private investors will rarely have the time or expertise to go and interview the company or fund manager to understand what is going on before they sell, so it must be based on emotion rather than hard facts.

This explains why the funds we invest in can do so well over a long period of time, but investors do not. You simply buy high when the going is good and sell low when fortunes are reversed. This happens time and time again. It’s kind of fun in the same way gambling is fun. That’s the problem with investing your own money, it becomes fun, but having fun, like any hobby usually costs money.

Taking a logical, systematic approach to investing is very difficult to do. Not least because after a while it just gets boring. In addition, as humans we are hard-wired after years of evolution to react to situations in ways that just doesn’t work well when managing your own investment strategy. Emotions like fear and greed are usually central to poor decision making. Cutting these out is impossible if you manage your own investments because we are all human and reversing thousands of years of evolution just isn’t going to happen. If you have invested your own money and experienced something like the chart above you will know what I mean.

 

*Meyer, Steffen, Schmoltzi, Dennis, Stammschulte, Christian, Kaesler, Simon, Loos, Benjamin and Hackethal, Andreas, Just Unlucky? – A Bootstrapping Simulation to Measure Skill in Individual Investors’ Investment Performance (June 6, 2012).

**CMG Focus Fund 10 years to Jan 2010

Blog by Jaskarn Pawar

Jaskarn Pawar is an experienced and award winning Chartered and Certified Financial Planner. He advises people all over the UK on financial planning and wealth management issues to help them reach solutions to fit their personal needs. You can contact Jaskarn on 01604 211234 or by e-mail on jaskarn@investorprofile.co.uk