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This is how much your investment behaviour is costing you

Over the long term, the biggest risk to your wealth could be yourself.

Warren Buffett is widely regarded as one of the world’s most astute investors. As chairman and CEO of Berkshire Hathaway, he has built up a fortune that made him the richest man in the world at one point.

His ability to identify companies that outperform over the long term has made him an icon of the industry. However, he recently gave Yahoo! Finance a powerful example of how simple it can be to be successful.

“I bought my first stock when I was 11 years old,” Buffet said. “It was the first quarter of 1942, shortly after Pearl Harbour. I spent $114.75 … If I put that $114 into the S&P 500 at that time and reinvested the dividends, think of a figure as to what it … would be worth today. The answer is about $400 000.”

That is an incredible investment return in one person’s lifetime, and it could have been gained simply by benefiting from long-term compounding. For that to be realised, however, one had to stay invested.

“Now, the market’s gone down many times during that time,” Buffett pointed out. “People have panicked during that time. Headlines have been terrible.”

There would have been many times when staying in the market would have been extremely uncomfortable. Yet resisting the urge to disinvest would have ultimately led to this extremely positive outcome.

The behaviour gap

It’s a lesson that has a high degree of relevance at the moment. There are any number of reasons why investors might feel uncomfortable right now, particularly given the low returns they have received over the past five years.

However, trying to time the market or pick where it might be best to move your money is rarely more productive than simply staying invested. This is emphasised by a study conducted by Momentum Investments and the North-West University into the cost of investor behaviour.

The research covered approximately 17 600 investors who had money on the Momentum Wealth Platform between January 2008 and January 2018, and investigated what impact switching funds had on their outcomes.

“We had a look at each investor, and what their strategy was when they started the journey, and compared that against what they ended up with after they changed funds,” explains Paul Nixon, head of technical marketing and behavioural finance at Momentum Investments. “We then tracked the two journeys. We looked at original strategy and what return they could have got, and compared that against what they actually got.”

What the study found is that 64% of investors switched funds based on past performance. An annual return from their fund of 3% or more below the previous year tended to trigger a switch to an alternative fund.

Doing this, however, resulted in a behavioural cost of 1.38% per annum for some of these investors.

Similarly, a return of 25% on a fund in which they were not invested tended to trigger a switch into that fund. Once again, however, this had negative consequences. It resulted in a behavioural cost of 1.05% for some investors.

Overall, nearly one in four investors incurred a behavioural cost of 1% per annum. That may seem small, but compounded over time it becomes substantial.

During the market crash of 2008, this doubled to one in two investors making a switch. The cost to them also increased to 1.1% per annum.

Avoiding mistakes

For investors, this is a stark lesson. It may seem like a reasonable response to move out of investments that are underperforming into those that are outperforming, but this actually – and demonstrably – destroys wealth.

Advisors also need to take note and be more cognisant of the role they should be playing.

“Your advisor should be the one standing between you and making a poor decision,” Nixon argues.

“Many advisors still believe their value proposition is picking funds. It’s not. Their value proposition is articulating your financial goals into something that you can understand and aspire towards.”

It is also, critically, a lesson for the investment industry. Asset managers tend to fixate on outperforming their peers, and this narrative is absorbed by investors.

However, as a study by the State Street Centre for Applied Research in 2014 found, this isn’t obviously delivering positive outcomes. While more than 60% of the industry’s capital is spent on the pursuit of alpha (outperformance), only 12% of individual investors could say with confidence that they were reaching their goals.

“The models for success in the investment management industry are broken,” State Street noted at the time. “Investment professionals pay significantly more attention to activities that they believe will contribute value to alpha. While some of these are helpful, many are of limited value. True success includes not only achieving alpha, it also requires helping investors achieve their long-term goals, sustainably, over time.”

This is about a lot more than just performance.

“From an industry perspective, I think companies are going to have to start spending more on showing that they actually understand their clients,” argued Nixon.

“If you are going to charge someone a fee you need to demonstrate value. So if you can start understanding why your investors are making decisions and engage with them more to ensure that they stay on the path and reach their goals, I think that is going to be what the future holds.”

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Patrick, as an investment professional with 24 years of experience, the one investment lesson I wish everone would learn, it is the one you have written about in this article today. Asset allocation drives long-term returns, and good investment outcomes are a result of patience and riding the ups and downs and being exposed to the assets capable of giving high returns i.e. equities and property.

People feel compelled to “do something” when they perceive poor relative or absolute returns from a portfolio. Switching from one portfolio or strategy to the next will almost inevitably lead to poorer investment outcomes on average.

My advice is, the following. Ensure your long-term asset allocation is aligned with your long-term liability profile. Select a strategy that will maintain that asset allocation over the long-term and then remain committed to the strategy.

My advice for this Friday morning – Steer clear of Financial Advsiors and Asset Managers.

Most people’s Financial Advisors take 0.5% – 1% and Asset Managers/their costs take 1 – 2%. So there you go on the low side you have paid out 1.5% for them to loose you money, both seriously eat into your gains and in my opinion are a the biggest negative to the man/woman in the streets investment behavior.

There should be a maturity test one has to take before you can answer to articles here and all onions should be blocked.

Dirkg, I am sorry to burst your little bubble, but some of the most knowledgeable investors the world over agree with my philosophy, it seems 90% more people here agree with me than agree with you. So maybe you should have a little rethink, or are you a broker or and FA?

Absolute nonsense, name a few “knowledgeable” people who think and believe this. In the meanwhile google a few people who know what they are talking about, here are some names: Michael Kitces, Paul Armson, Mitch Anthony, Vanguard’s article https://advisors.vanguard.com/# . These peoples qualified knowledge might enlighten you this weekend unless you want to stay in your bubble.

This is the same as telling somebody who is ill to treat themself and not go to a doctor. It might work if (a) you are lucky and there is nothing seriously wrong with you (b) you are a doctor other person with medical knowledge.

Very poor advice for a person with limited financial knowledge to do it themselves

Just as a doctor has a right to fees financial services professionals have a right to fees.

A doctor charges a once off fee, and so should investment professionals.The problem is the ongoing fees as a % of your portfolio.

Fully agree, the after inflation and after tax return of a portfolio is around 4% typically, so the adviser fee of lets say 1% is actually 25% (1%/4%) of your annual profits!

The asset manager fee of 1.5% is actually 37.5% of your annual profits. And they make this with zero risk to themselves…

Financial planning and Investment advice are two different tasks, lumping them together is like saying farming and cooking are the same. This is where advisers go wrong and clients/the public need educating.

Sideways Onion: your calc of throwing away 1.5% for advice and asset management is incomplete. A typical asset manager pays a total of 0.5% for a buy and sell trade in the market whilst a self help investor pays anything from 2 to 3% (buy cost plus sell costs) Depending on how active you are your Total own self help costs may be even higher than the total costs through intermediaries. So at the end of day I would suggest you rather focus on how much better you are as a self help investor compared to the professionals.

NYBoertjie,

My point is put your money offshore in a passively managed index fund and leave it. In my opinion it will do a lot better than and 99% of actively managed funds.

Absolute true! Only look after themselves and poor service is a trademark especially as time goes on. As soon as their motives are questioned their interaction reduce, can’t read, can’t write, can’t hear, can’t talk and cell don’t work.BUT still take the money

Dirkg you say “Financial planning and Investment advice are two different tasks, lumping them together is like saying farming and cooking are the same”.

Okay so let me try explain….Everybody gets the above, the point you do not get and 95% of people here obviously do, is these 2 professions eat into a portfolios gains, anyway to try swing it.

I will wager the 2 likes you have are FA’s or Brokers…….lol

Notwarren, Medical professionals do not charge a %, they charge a fixed fee, so that argument is moot.

Essence of the article should be put your money on the index, you can do that yourself. One local say top 40 index and one international say MSCI world. Or if you have more knowledge then you may construct your own index portfolio. Momentum I wouldn’t invest with them for zero fees.

Sideways you are missing the point. The point is most investors can’t handle a period of negative returns.They capitulate and in doing so destroy their returns. Psychologically they can’t take it. Even the boring, massive R140 billion Allan Gray Balanced fund has compounded at over 16% annually for now almost 20 years. That’s net of fees. It’s made many people very rich. Take another percent off for advice end you end up at around 15%. Beats even the JSE over that time and it holds cash and bonds. It’s not rocket science, do it yourself.

Millerslaw,

The rand was 6.20 to the $ in 1999, the year of the year Allan Gray started Balanced fund, 20 years later the rand is 14.4 to $1,
In 1999 SAP500 = 735
In 2019 SAP500 = 2917
In 1999 NASDAQ 100 = 1175
In 2019 NASDAQ 100 = 7781

Now taking into consideration the Rands depreciation over those 20 years and the gains of the 2 example indexes above over the same period, tell me where you would rather have been invested, in the actively managed Allan Gray Balanced or passively managed index like the SAP or NASDAQ?

Sideways yes we’ve all heard that one. Either way you would have done well. But most people havent because they pulled out at the bottom of the GFC or other crises. They never got those returns. Irrelevant if you were living in SA in 99 anyway. It was a small world and daddy was still hiding travellers cheques in his backpack when he visited London let alone investing in the S&P or Nasdaq.

Remember that Rand “depreciation” is due to the higher inflation rate we have. Our purchasing power is doing just fine looking at the big fancy houses and cars people own. In the end it is the purchasing power that is important not the exchange rate.

MoneyChief,

The rand depreciates, the cost of oil increases, this directly affects, industrial’s, transportation, food, the cost of electricity, foreigners pull out of the JSE, which indirectly affects everyone’s pensions and the rest is history. Purchasing power must always be looked at in real monetary terms ($,Pound,euro). Looking at what the rand can buy you in SA, is a very short sighted way of looking at it. On the 6th September 2013 A 10 million Rand house would have cost you a million $. Today the Same 10 million rand house will cost you about $690k. So ask yourself, how much has Rand depreciation affected our purchasing power on the global scale?

It is very telling that after he dies, the money that Warren Buffett leaces to his family will be invested in index funds.

Additionally, he wronte the foreword to John Bogle’s book: The Little Book of Common Sense Investing.

Worth a read. Basically says that financial advisors and switching eats about 50% of your returns in the end. Active funds/advisors taken fees whether your cash is increasing or decreasing. Bear in mind that just as returns compound, the fees that are taken from those returns compound too and those are what you lose in the end.

The Spark,

100% correct, that is what I tried to explain to Dirkg.

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