I’m lazy. That’s not necessarily a bad thing. It means that I look to maximise the effort v reward trade off. What’s the most return I can get for the least effort. To borrow from Pareto (him of 80/20 rule fame), what’s the 20% of effort that will get me 80% of result I’m after? Most of the way there, without doing too much different.
We when it comes to money this is simple (but not easy).
BEHAVE
That’s it. Don’t do the stuff that doesn’t work (that most other private investors do). Here’s are the top four destroyers of personal wealth
- Not being sufficiently diversified
- Trading too often
- Buying high, selling low
- Paying high fees
They are all behavioural issues. Lets look under the bonnet of each in turn to see what’s really going on here
Diversification reduces risk.
Fact. Nobel Prize in Economics kind of fact. Until Harry Markowitz proved it in 1952, the popular belief was that investment success came from finding 2-3 sure fire stocks that would shoot the lights out. Buy them, sit back and enjoy the returns. Markowitz was able to prove that diversification reduces risk. Seems a crazy stance now. I guess they didn’t keep eggs in baskets in the 1950s.
But what does not being sufficiently diversified look like? Well a common example I see when looking at a typical diy portfolio is 5 UK equity funds (from 5 different fund houses). This is not diversification.
Firstly, there is a strong chance that each fund manager is buying at least some of the same stocks. After all they’ve all got teams of analysts pouring over the same public and private data. There’s a good chance that they reach the same conclusion about what to buy (and when to buy it).
Secondly, the UK represents only a tiny fraction of the global stock market (less than 5% at the end of 2021). Having 100% of your investments concentrated in a single country that accounts for only about 5% of the global stock market seems quite just about the opposite of diversified to me.
Don’t just do something, stand there.
There’s a myth (perpetuated by the fund management industry) that there exists some innate ability for fund managers to work out what to buy and when to buy it.
Just think about that for a minute. Working out what to buy and when to buy it is nothing more than trying to predict the future. There is no crystal ball of investing (or anything else for that matter). They have the access to the same data as everyone else. Are they equipped with foresight and insight that none of the other fund managers possess? No. Not only do they just believe in fairies, they believe they are fairies.
So because we’re fed the lie that the experts can predict the future we try to emulate them. Buy, sell, research, pump and dump, etc., etc. This is pure folly. It can’t be done. We’re conditioned to believe that we must do something. Act, decide, actions, decisions, analyse, research.
It’s not just fund management. It’s everywhere. Don’t believe me go on to YouTube right now and search for ‘penalty shoot outs’. Look at how often goalkeepers dive left or right and how often penalties are hit down the middle. Even goalies feel the pressure of being seen to do something. They can’t just stands still and wait for the ball to get hit at them.
Safety in numbers
Humans are social animals. Belonging, being part of the herd made us survive. Yes we need to stand out a little bit to get noticed but also need to find our tribe. This is one reason why some teenagers have a tough time. They are trying to identify their own identity, whilst finding their ‘group’. All this at the exact same time that their brains are re-wiring.
To fit in we follow the herd. We want to look the same. Act the same. Belong. Buy the same things. It’s why there’s fashion, why it changes over time and why fashion differs between regions. It applies to money too.
We invest in the same things. We want to own the same investments as other people like us. Now that’s not too bad if it were not for one fundamental flaw in our psychology - the thinking that enabled us to survive in the past will not lead to success with money.
The pleasure we feel from a gain is less than the pain we feel from a similar sized loss. Put another way, we feel loss more deeply than gain. And it’s been quantified too. The pain of a loss is about 2.5 times the pleasure of a gain. A win of £100 is the same as a £250 loss. This aversion to loss means that we don’t want to buy things that lose value.
So we buy investments that have already gone up. They cost more than they did. That makes them valuable. Everyone else is buying them so it must be safe. But the increased demand over supply is what drove the price up). We’ve bought high. But the price keeps going up. More people pile in. This is going to go on forever. We’re riding the euphoric wave of investor invincibility.
But it doesn’t last. The bubble bursts, with a bang. The price falls, we’re losing money. We hang on. It’ll come back. But other people in the herd are panicked. They sell. Now there’s a bit more supply. The price drops more. Now more people sell. There’s too much supply and the price enters free fall and we decide to sell. This is buying high, selling low. This behaviour destroys wealth.
Investors burned by the market may not ever re-invest. They remain in cash, blaming the market sharks fr chewing them up and spitting them out. Or worse.
They wait until there’s the next sure fire investment. Guaranteed to keep going up. This time it’s different. They watch the price. It keeps going up. Everyone’s in on it and they’re making a packet. So they go all in, buying high and they get taken to the cleaners (again). They will repeat until broke (or broken).
A rising tide lifts all boats
Investment ees matter. A lot.
Ignore them at your peril. Let me explain by comparing two funds; Fund A and Fund B
Fund A has a 1% charge per annum. That means if the fund has to return 1% more than inflation for the investment to maintain it’s purchasing power. Fund B has a 2% charge and the fund will need to return 2% more than inflation to maintain the investor’s purchasing power.
Where is that additional 1% return that fund B needs (just to match fund A) coming from? They are investing in the same stuff. With the same return.
Don’t be misled by thinking it’s only an extra 1% that’s not too bad. An extra 1% every year for 10 years is 10.5%.
Here’s some actual numbers. £10,000 invested in fund A with returns of 5% per annum you’d have £14,802. £10,000 invested in fund B with a 5% return per annum you’d have £13,439.
That’s a difference of £1,363. Put another way, by owning fund B you’ve overpaid by £1,363 for the same return you could have got in fund A.
Over 30 years (of retirement funding or retirement spending) reducing fees by 1% will give you an extra 35%. That’s £35,000 on £100,000. Who wouldn’t want an extra 35%.
So the key to investment success is to behave. It trumps all other factors when it comes to investing and the good news is that its is the only part of the investment process that you are fully in control of.