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An Investor’s Greatest Enemy

Over the past 11-plus years from 11 April 2002 to 31 Dec 2013, Singapore’s stock market has grown by an annualised rate of 8.36% a year after factoring in reinvested dividends. I got this figure off the performance records of the SPDR Straits Times Index ETF’s (SGX: ES3), an exchange traded fund that essentially tries its best to mimic the Straits Times Index’s (SGX: ^STI) movement.

That kind of return allows an investor to double his or her money in slightly less than nine years. Can the fund achieve similar returns in the next decade or two? I can’t tell for sure.

But what I do know is, there would not be too many investors who would be able to double their money after nine years while invested in the ETF even if the fund itself can go on to achieve historically-similar gains.

The source of poor returns

Financial advisor and behavioural investing expert Carl Richards made a Tweet a few days back saying, “Behaviour Gap exists in index funds as well: Vanguard S&P 500 index fund 15 yr return: 4.58%. Average investor in the fund: 2.68%.”

The behaviour gap, as coined by Richards, is used to describe the financially-harmful behaviours investors often exhibit that lead to big differences between an investment’s returns, and an investor’s returns.

And, these financially-harmful behaviours often stem from our behavioural biases such as an aversion to losses, overconfidence in our own trading-abilities, and the perilous need to rely on forecasts despite the extremely poor track-record of even professional forecasters.

Ultimately, these biases surface in investors taking concrete, wealth-destroying actions such as piling into an expensively-priced investment after it becomes extremely popular; selling shares of fundamentally-strong business just because of temporary price declines; taking on undue leverage to get rich quick without being cognizant of the risks involved; and not having enough patience way to allow time and compounding to work in our favour, among others.

The behaviour gap surfaces time and again when studies are conducted on the differences, if any, between investment and investor returns.

For instance, David Swensen, the highly successful chief investment officer of Yale University’s US$20b endowment fund, once shared how the average American investor in equity mutual funds (the equivalent of unit trusts here) in the US had badly trailed their fund’s returns itself, sometimes by more than 13% per annum!

The reason Swensen gave for the investors’ appalling results was that “they bought after the funds had gone up, and they sold after the funds had gone done.” That’s the behaviour gap at work!

How to improve

I would love to see statistics, if any, that show how the average investor in the SPDR STI ETF had fared as compared to the fund’s own historical return. While some might say that Singaporean investors are perhaps different and might not fall prey to the behaviour gap, I beg to differ.

Here’s what I wrote on the topic previously:

…despite vast cultural differences between people from different parts of the world, there are still a great deal of similarities that exist in human nature…

…Richards once said that he was struck by how greed and fear toward money and wealth was almost universal in the people of all the different countries he’s been to. And incidentally, greed and fear are likely to be the two strongest human emotions driving the markets here, in the USA, and everywhere else in the world.”

So, if you believe, like I do, that investors here in Singapore are equally susceptible to the behaviour gap as any other investor from other parts of the world, then the following tip might be very helpful in closing that behaviour gap: Keep an investing journal or at least have a forum or sounding board where you can put pen on paper or fingers on a keyboard.

When we start recording our investing thoughts, we bring more logic into play, which lessens the impact that our emotions have on our thinking.

When we pen down business-based reasons for buying and selling a share before any investment is made, that can also serve as a calming influence for us whenever prices rise or decline sharply.

For instance, retailer Dairy Farm Holdings (SGX: D010) and commercial inspection and testing firm Vicom (SGX: V01) were both growing their profits through the Great Financial Crisis of 2007-2009, increasing the intrinsic value of their businesses. But, that didn’t stop their prices from crashing by at least a third or more during the crisis from the day the STI peaked on Oct 2007.

Today, Dairy Farm and Vicom are some 84% and 312% higher than where they were back then, even as the index’s still 19% lower. An investor who panicked and sold out during the price declines would make for a great example of the behaviour gap at work.

Foolish Bottom Line

The great investing pioneer Benjamin Graham once wrote that “The investor’s chief problem – and even his worst enemy – is likely to be himself.”

With the abundant existence of the behaviour gap, Graham was right. We can spend all our time and effort in unearthing the best investment opportunities out there, but if we allow bad investing-related behaviour to get in the way we’ll just be falling into the pits of the self-induced behaviour gap over and over again.

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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 writer Chong Ser Jing doesn’t own shares in any companies mentioned.