It might sound strange – growing your wealth by sitting around. After all, many of us have been taught that we need to work hard for our own success. In fact, another saying also goes that “no success comes without hard work”. And yet, a May 2013 study by American mutual fund powerhouse, Vanguard, proves just the opposite. Vanguard investigated the returns of 58,168 individual investors’ accounts for the five-years ended 31 December 2012. It found that investors who made changes to their portfolio during those five-years ended up with worse results than those who simply did – get this…
It might sound strange – growing your wealth by sitting around. After all, many of us have been taught that we need to work hard for our own success. In fact, another saying also goes that “no success comes without hard work”. And yet, a May 2013 study by American mutual fund powerhouse, Vanguard, proves just the opposite.
Vanguard investigated the returns of 58,168 individual investors’ accounts for the five-years ended 31 December 2012. It found that investors who made changes to their portfolio during those five-years ended up with worse results than those who simply did – get this – nothing.
Vanguard’s study suggested that “some of the [portfolio] exchanges were surely reactions to market events, and these investors paid a price for failing to maintain portfolio discipline”.
There have been other empirical studies, which show that active trading can be hazardous for long-term wealth. Thing is, why are investors still suffering from itchy-finger syndrome even if they know the better odds of success lies with sticking to tried-and-tested strategies such as buying undervalued shares and holding it for the long-term?
We could point the finger-of-blame at our brains. The field of behavioural finance has found many common quirks in our thinking, which leads to financially harmful behaviour. One such quirk would be overconfidence.
Try asking a room filled with a 100 random people how they rate their driving skills and more than 75% will likely say they are better than average. That’s overconfidence at work – we often overestimate our own odds of success.
For a more serious example, take this study done in Sweden, recounted in Jason Zweig’s book Your Money and Your Brain.
Two groups of people – the first group comprised experienced professionals in the investment industry, while the second group of college students who were greenhorns in the stock market – were told to pick a winner between two stocks and, crucially, to estimate their own odds of success at making the right choice.
It turns out, the first group were confident of making the correct stock pick 67% of the time while the second group rated their odds of success at only 59%. But, while the amateurs did slightly better than a coin flip with a success rate of 52%, the stock-picking pros only got it right only 4 out of 10 times! A coin-flipping monkey would have done better!
The investment professionals’ years of experience only convinced themselves that they were better at it but failed to convince the stocks they picked to go up like they thought it would. Simply said, overconfidence can lull us into thinking we’re more accurate with our predictions about the future without actually improving our accuracy, especially when we are familiar or knowledgeable about the particular subject we’re quizzed on.
Think about the implications here. For investors who have had experience trading stocks, we think we know the stock market. Because of that, we think we’re better at second-guessing short-term movements when in reality, that’s not true. And that’s the danger with overconfidence.
Vanguard raised the important point of maintaining “portfolio discipline” instead of actively trading in and out of the market. That’s absolutely in-sync with what investors can do to downplay the effects of overconfidence. We first have to know that we’re almost never as good as we think we are and then stick to disciplined investing.
This involves the discipline to buy undervalued shares; to hold onto fundamentally strong businesses even if its share prices fall; and to be firm in taking a long-term view of the share market. These are essentially what have been proven to work over the long term in investing. For those unsure, feel free to check with American billionaire investor Warren Buffett.
During the Great Financial Crisis of 2007-2009, the stock market, as represented by the Straits Times Index (SGX: ^STI), was trading at 6 times its historical earnings near its trough. That’s a very low valuation that it did not reach even during the Asian Financial Crisis of the late 1990s.
Turns out, the STI bottomed out at 1,456 points on March 2009 and has since climbed 129% to 3,319 on 11 Dec 2014. Investors who bought the STI, through index trackers such as the SPDR STI ETF (SGX: ES3) and Nikko AM Singapore STI ETF (SGX: G3B), on the basis of investing in undervalued shares, did very well as valuations rose to its current level of a PE of around 13.4 and earnings of the STI’s components grew.
That’s not all. Investors who bought health care provider Raffles Medical Group Ltd’s (SGX: R01) shares at $1.58 on November 2007 during the pre-crisis peak would now have more than doubled their money at the company’s current price of around #3.90. But, that was not before RMG’s shares plunged by 65% at the trough of the GFC, proving why it can be lucrative to look beyond short-term price declines.
Finally, investors with the mental fortitude to hold onto shares like infrastructure-engineering firm Boustead Singapore Limited (SGX: F9D) and retailer Dairy Farm International Holdings (SGX: D01) for more than a decade since the start of 2003 would have seen total returns in excess of 1,420% and 1,728% respectively! Those gains make great poster boys for the benefits of taking the long-term view.
Foolish Bottom Line
Legendary value investor Benjamin Graham once wrote that “the investor’s chief problem – and even his worst enemy – is likely to be himself.”
Overconfidence is just one way our worst enemy manifests itself to us. Take his destructive powers away by realising that lesser activity can be better for your wealth.
Click here now for your FREE subscription to Take Stock Singapore, The Motley Fool’s free investing newsletter. Written by David Kuo , Take Stock Singapore tells you exactly what’s happening in today’s markets, and shows how you can GROW your wealth in the years ahead.
The Motley Fool’s purpose is to help the world invest, better. Like us on Facebook to keep up-to-date with our latest news and articles.
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.