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In Investing, You Can Be Your Own Worst Enemy

In the 29 years ended 2002, the NASDAQ Index (one of the three major American stock market indices, including the S&P 500 Index and the Dow Jones Industrial Average) returned almost 9.6% per year. That’s fantastic right? I mean, an investor who plonked $10,000 into it at the start of 1973 would be sitting on $142,700 now.

Unfortunately, that’s all in theory. As the famous American baseball personality Yoggi Berra once said, “In theory, there is no difference between theory and practice – in practice, there is.”

Turns out, the average American investor only earned 4.3% a year. Translated into dollar amounts, the same $10,000 investment would have become only $33,900.

I find it remarkably stunning that there is a big difference between investment returns versus investor returns. But, why the big difference there? In short, it’s our emotions.

Carl Richards, a certified financial planner and columnist at The New York Times, is well known for using the term, The Behaviour Gap, to describe differences between investment and investor returns.

From 1973 to 2002, the Nasdaq gained 9.6% a year. But an investor can only earn that return if he had invested money on 2 Jan 1973 and left it there untouched till 31 Dec 2002.

In reality, hardly anyone is able to do that because of the emotions we experience during stock market ups and downs – we saw that with the average returns that investors earned in the Nasdaq in the same period.

When markets swoon, most feel overwhelming fear of losses and start selling stocks despite the fact that they should have been buying because stocks generally become better bargains at lower prices. When markets go on a huge bull run, it’s greed that’s taking over and even stocks that have expensive valuations suddenly look like bargains.

All these leads investors to commit a cardinal sin in investing – buying high, and selling low. Greed and fear, and a whole host of other emotions we feel with money matters, is why there’s the behaviour gap.

This naturally leads to the question, how do we prevent ourselves from letting our emotions led us to making stupid mistakes?

For starters, keep an investment journal. Before purchasing any shares, write down business-based reasons for doing so. Even simple ones like “The business is recession proof and earnings are going up faster than its Price-Earnings ratio” can work. More importantly, those reasons have to be logical. And before you ask, ‘because the price will go up’ is not valid.

Then, write down reasons that will make you sell – and no, ‘the price has gone down’ doesn’t count. Think ahead of the kind of bad developments that might make you part with those shares. “The business is founder-driven and I’ll sell if he leaves” is a simple but valid example of a reason to sell.

When the stock market inevitably crashes sometime in the future (I honestly don’t know when), check back with the journal before making any hasty, emotion-led decision to sell because of falling prices.

Foolish Bottom Line

Ultimately, our emotions are very much a part of us. But if we let it run amok when we’re investing, then we’ll truly become our own worst enemy.

According to Yahoo Finance, over the past 10-odd years since the start of 2003, the Straits Times Index (SGX: ^STI) has gained 8.4% per year

Blue chips like Jardine Matheson Holdings (SGX: J36), Singapore Exchange (SGX: S68), and United Overseas Bank (SGX: U11) have had average annualised returns (including dividends) of 23.5%, 20% and 8.8% respectively in the same period.

Those are great investment returns. Problem is… are our investor returns similar?

Benjamin Graham, the intellectual father of value investing, once wrote decades ago in the late 1940s that “The investor’s chief problem – and even his worst enemy – is likely to be himself.” He’s prescient. And he’s right.

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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.