It?s sad to see investors get burnt in the share market, get scarred and then forsake a great avenue to build long-term wealth. Thing is, investors can be clueless about the real reasons for their poor investment returns and blame the market, instead of trying to fix the root causes for their abject performances.
With knowledge of the reasons behind poor returns and how to improve their performance, perhaps there would be lesser sob-stories…
It’s sad to see investors get burnt in the share market, get scarred and then forsake a great avenue to build long-term wealth. Thing is, investors can be clueless about the real reasons for their poor investment returns and blame the market, instead of trying to fix the root causes for their abject performances.
With knowledge of the reasons behind poor returns and how to improve their performance, perhaps there would be lesser sob-stories of investors losing fortunes or just plainly refusing to invest in the share market because of fear.
Common reasons for poor performance – hint, it’s you!
Research have found over-trading to be a common source of poor investing returns and it stems from overconfidence. Simply described, overconfidence is the mental trait of thinking we are better than we really are in whatever is the activity in question.
Translated into the share market, overconfidence manifests itself when we think can out-guess the market in terms of short-term movements resulting in us trading actively, trying to capture each mini-peak-and-trough. Unfortunately, that just leaves active traders poorer, more often than not.
The disposition effect is also commonly cited as one of the main reasons for poor investing performance from investors. It stems from the tendency for humans to feel more psychological-pain when faced with a loss as compared to the psychological-delight that we feel when we have an equivalent unit of gain.
This causes investors to hang onto losing shares while selling of winners too quickly. That’s – to put it simply – bad. The opportunity costs of hanging onto losing shares instead of transferring those funds to better opportunities can be immense.
We just have to take the experience of Singapore Airlines (SGX: C6L) and Jardine Matheson Holdings (SGX: J36) as an example, as seen in the chart below. From Jan 2000 to 8 July 2013, SIA has registered a 47.7% decline. Compare that with JMH, which has increased by more than 1,324% and it’s easy to see what investors in SIA might have been missing out.
The use of JMH to compare against SIA might be seen as cherry-picking of data but it serves to exemplify the enormous opportunity costs that investors have to bear if they had clung onto SIA for the past 12-odd years instead of re-investing the money somewhere else.
Source: Yahoo Finance
Fret not – there’s hope
Fortunately for investors, it seems that we do learn from experience. Research done by three economists on 19,847 German investors’ trading history over a period of 8 years suggests that investors do learn from their mistakes. They realised the folly of excessive trading and started to avoid it, leading to a lower portfolio turnover.
So what does this tell us? Besides saying that excessive trading can be harmful to our long-term wealth, the research also brings home the point of starting as early as possible.
The earlier we start, the more time we have to allow our experiences to accumulate to become better investors before we hit the generally accepted retirement age of 65. That’s just good simple advice. But equally important, is the fact that starting earlier gives compounding a chance to work its magic sooner.
Compounding is powerful, but it takes time
Let’s consider two investors, John and Jane. John is currently 25 years old, has just started investing, and would retire at 65 by which time he would stop investing. Jane is currently 35 years old, has just started investing, and would also retire at 65 and stop her investing too.
Both investors had invested in the Straits Times Index (SGX: ^STI), which has grown from 834 points at the start of 1988 to 3,179 on 9 July 2013, giving it a compounded annual return of 5.4% over the past 25-and-a-half years.
If we assume that the STI’s returns over the next 30 to 40 years would be similar to its past, then John would have gotten $8,200 when he’s 65 for every $1,000 that he has invested into the index now. On the other hand, Jane would only have $4,800, almost half of what John would have!
The difference in the ending amount is stark even though their investing time-line only had a 10 year difference. With compounding, it really pays to start early.
Foolish Bottom Line
Knowing what’s causing us to perform poorly when investing allows us to take charge and fix those problems. Investing in the share market is a valuable way to build long-term wealth. We shouldn’t allow previous mistakes to deter us from it.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.