We’ve all been enjoying the bull market. But getting a historically respectable 6 per cent return, or even doubling it, can feel underwhelming when the economy is roaring ahead and the Nasdaq has gone up 30 per cent. From what I see, the difference between the big winners and the also-ran-investors often comes down to whether or not they let their biases cloud their judgement. Even experienced investors are not immune.
It’s such a big problem that an entire field of study has sprouted out of this: behavioral economics. Economist Richard Thaler won a Nobel prize for his work looking at how these biases operate among humans in a supposedly rational market.
Here’s a roundup of the worst mistakes I see again and again from DIY investors (which is why a lot of these people would be better off with a set-it-and-forget-it strategy).
Running with the herd
If you want an above-average return, then don’t rush into what the crowd is doing.
Probably the most outrageous example of this mistake is to be found in the irrational exuberance over Bitcoin. Just $1,000 worth of Bitcoin from a few years ago would be over $1 million today. If you threw caution to the wind and invested in this years ago, then you have certainly seen the kind of ROI that Wall Street hedge fund managers can only dream of. But all those gains are in the past, to the benefit of the early adopters.
The vast majority of investors have arrived late to this party. Most of the large gains have already been captured. And while there may be more growth yet to come, experts say that Bitcoin eventually seems destined to repeat its bust cycles of 2011 and 2014. The herd is about to race off a cliff. Usually, by the time your neighbor next door is jumping on the bandwagon, it’s already past time to get off.
We all know that past performance is no guarantee of future returns. And yet, it is basically human nature to ignore that knowledge.
In life, recency bias is actually a useful rule of thumb a lot of the time. Your friend who always shows up late will show up late again. The restaurant you liked years ago, but whose quality keeps declining will continue to suck, in new and intolerable ways.
For investing, recency bias can really do harm. We see a line graph showing a steadily-rising return, like with the Nasdaq: well, why wouldn’t that trend continue? Because it can’t. Over time, as an asset rises in value, we can expect it to fall back down to the mean.
The market goes up. It goes down. Stocks representing individual companies rise and fall thanks to the leadership of their CEO (Elon Musk versus Travis Kalanick) and a million other variables. Oil goes up, gold goes down … and around and around we go.
The movement isn’t random. An experienced investor knows to look for clues that a given asset is undervalued. So remember that familiar warning you know about past performance. Act accordingly.
Optimism is overflowing thanks to 2017’s performance (There’s that recency bias, again). But not everyone sees unfettered prosperity ahead. With every boom, comes bubbles — and eventually, a bust. 2018 may not be the year the party ends, but a correction (or series of them) seems overdue. At the same time that markets seem poised for a correction, interest rates keep rising. Geopolitical tensions continue to rise.
Which stock is the next Facebook? How do you avoid an earnings snap-back like Snapchat? Bonds, REITs, and preferred shares: lions, tigers and bears, oh, my. Savvy investors will need to sharpen their pencils and make some harder choices.
There is such a bounty of options that even the most experienced investors can be confused. Confusion leads to hesitation. Hesitation becomes paralysis – and your cash thrown into a savings account earning less than 2 per cent – if you’re lucky! And that is something you absolutely want to avoid.
When it comes to investing your money, not making a decision is a big decision. It means your money isn’t working for you. Even if you’re waiting and hoping to time the market (a fool’s errand, much of the time), the simple truth is that even investing in a boring balanced fund will deliver an average return that is far superior to doing nothing.
You might choose to work with a professional who knows to avoid these mistakes. Today, there are much lower cost options that can provide better returns without a premium fee.
Neville Joanes is the Chief Investment Officer of WealthBar, a robo-adviser. WealthBar provides unlimited financial planning with lower-fee ETF portfolios and actively managed Private Investment Portfolios. Through their financial advisers, easy-to-use online dashboard and financial tools, they make investing more accessible to all Canadians.