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Staying power

01 September 2017

Studies suggest that not quitting could be one of the most profitable investment decisions you ever take.

Winston Churchill once said: “Never waste a good crisis.”

Yet many investors are often too busy panicking to take the advice. When markets dip or geopolitics take a turn for the worse, the knee-jerk response is often to sell quickly. However, a recent study by DALBAR, a Boston-based financial research group, shows how expensive such an approach tends to be.1

While the trends identified in the report are consistent over many years, 2016 provided “a wonderful case study for investor behaviour”, according to DALBAR, triggered most notably by surprise political events on both sides of the Atlantic.

The DALBAR analysis, which covers a 30-year period to the end of 2016, examines the buying, selling and switching habits of US mutual fund investors to calculate an ‘average investor return’ for various time periods, which is then compared to the returns of respective market indices.

The conclusions are clear, if unsurprising. Investment results are more dependent on investor behaviour than on fund or market performance. Those who hold onto their investments in the face of apocalyptic financial headlines and short-term volatility have been more successful than those who let fear get the better of them, or who try to time the market to execute the perfect strategy; buying low and selling high.

Bad timing

Markets again proved wildly unpredictable last year – largely due to the political turmoil triggered by shock results at the polls – and provided ample opportunities for negative investor behaviours to raise their ugly head.

For example, on Brexit polling day, markets surged on expectations that the UK would vote to remain in the EU, then suffered their worst single-day loss in years as investors reacted to the result. Yet in less than week, the S&P 500 had recovered 80% of its post-referendum losses, whereas those who had fled the market were left behind.

Albeit over a shorter timescale, a similar chain of events surrounded Donald Trump’s surprise victory in the US presidential election. Markets performed well in the run-up to the vote, as investors believed that a Hillary Clinton presidency was likely and would be more conducive to growth.

In the event, Donald Trump’s victory was announced only after US markets had closed, but Asian markets immediately suffered losses – the Nikkei 225 in Japan dropped around 5% immediately. Many US investors quickly sold off assets too, and leading US indices fell sharply in early trading the following day.

However, by the time it closed in the afternoon, Wall Street was in the black and a rally had ensued – at time of writing, the S&P 500 has gained some 13% since 9 November last year.

The best three months of 2016 (March, July and November) coincided with either neutral or negative cash flows into mutual funds – investors were coming out of the market at the worst possible time. Consequently, the average US mutual equity fund investor achieved a return of 7.26% whilst the broader US equity market (represented by the S&P 500 index) returned 11.96% – a difference of 4.7%.2

Over the long term, the DALBAR study demonstrates a similar trend, and also reveals that mutual fund investors seldom manage to stay invested in their funds for more than four years; not long enough to execute a long-term strategy.

 

Investment term (all ending 30/12/2016)

Average equity investor returns (annualised)

Average market returns: S&P 500 index (annualised)

Difference

3 years

3.42%

8.87%

5.45%

5 years

9.83%

14.66%

4.83%

10 years

3.64%

6.95%

3.31%

20 years

4.79%

7.68%

2.89%

Source: DALBAR

 

Differences can appear insignificant on a year-to-year basis, but the impact of annualised returns on the long-term value of an investment is considerable. Thus a £10,000 investment, with average market returns of 7.68%, would be worth £43,923 after 20 years. Yet the average investor, dipping in and out of the market, would only have achieved a return of £25,491 over the same period – just 58% as much.3

Focus on the goal

The research reinforces the assertion that investors with a short-term focus often cost themselves money because their behaviour is almost always irrational. They may start with a plan, but that plan is only as good as their willingness to stick to it.

Markets can have a bad day, week, or even year, but investors who have set their goals over a realistic time horizon, and can retain confidence in the outcome, are less likely to overreact and more likely to achieve what they set out to do. In simple terms, they can avoid becoming their own worst enemy.

 

1 DALBAR’s 23rd Annual Quantitative Analysis of Investor Behavior, February 2017
2 As above
3 Source: DALBAR

 

The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up.  You may get back less than you invested.

© S&P Dow Jones LLC 2017. All rights reserved.

Some of the products and investment structures documented within this article will not be available to our clients in Asia. For information on the funds that are available please get in touch.

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