Mistakes are the best teachers. One does not learn from success. It is desirable to learn vicariously from other people’s failures, but it gets much more firmly seared in when they are your own. — Mohnish Pabrai
Some of life’s mistakes are more costly than others. One may not rear its ugly head until many years down the road, while another is capable of delivering an immediate knockout punch. Money mistakes are able to do both.
Odds are you’ve made some pretty good money decisions, and you’ve made costly mistakes as well. Nobody is immune from mistakes. None of us are smart enough, lucky enough or insightful enough to completely eliminate mistakes from our lives.
But you can take steps to improve yourself as a money steward and investor, and elevate the state of your overall financial wellness by minimizing the frequency and severity of your mistakes, learning important lessons from them and correcting course as necessary.
Chasing the Unicorn
It’s easy to fool yourself into believing that you are going to be the one to beat the market with your newest investment infatuation.
Wall Street has no problem with your new puppy love self-deception, but let’s be clear: While some investors do beat the market using a very disciplined approach conducted over very long periods of time, most investors do not, because the human condition gets in the way.
Both unique personal characteristics and our shared humanity can cause us to be overconfident in our abilities in just about everything we do. We all seem to think we’re at least a little above average, so certainly we can pick the stock winners easily and consistently, right?
The overconfidence cycle looks something like this: Overconfidence leads to enthusiasm, which leads to unrealistic expectations, which leads to faulty investment decisions, which leads to poor performance, which leads to fear, which leads to selling too soon and too often. It all leads to really poor investment performance. The end result: It’s not me, the market sucks.
So, if you shouldn’t chase the unicorn, what should your goal be?
To be average.
The long cycle can be brutally destructive because you will be out of the market during very important and profitable times because the fear and disenchantment caused by your own unrealized and unrealistic expectations is very real.
What’s worse is published returns (past performance) look reasonable and attainable, but actual investor behavior belies the fact that investor performance deviates dramatically from investment performance. Not often reported is the fact that investment performance is not indicative of investor performance.
Dalbar, Inc. is the nation’s leading financial services market research firm that publishes their annual Quantitative Analysis Of Investor Behavior study. It’s an eye opener!
Directly from the Dalbar website:
Since 1994, DALBAR’s Quantitative Analysis of Investor Behavior (QAIB) has measured the effects of investor decisions to buy, sell and switch into and out of mutual funds over short and long-term timeframes. These effects are measured from the perspective of the investor and do not represent the performance of the investments themselves. The results consistently show that the average investor earns less – in many cases, much less – than mutual fund performance reports would suggest.
According to Dalbar’s latest published study, their 26th annual report measuring performance through December 31, 2019, the typical investor in equity mutual funds has gotten only a 3.88% annual return over the last 20 years! After investment costs (commissions and fees), inflation and taxes these palty positive returns actually go negative! In other words, they lost.
The gap is alarming. Why the disparity?
Investor behavior, especially in times of turmoil, may become pancilky and erratic as fear sets in. And what do many investors do when there’s trouble? That’s right. Bail.
Chasing the unicorn (investment performance) is counterintuitive and counterproductive.
If you do the research and inspect what’s really behind the numbers, you will find the real reasons for outperformance. It can be the manager (but not often). More often the reason is trends and fads that boost performance for a period of time but may not last.
And if you rely on past performance for future performance you are setting yourself up for one hell of a hangover. If you forget that those higher returns are almost always accompanied by higher risk you are going to have many investing regrets, and probably a lot less money.
So, how important is past performance then?
It does give you an indication of how an investment manager did against the benchmark index or indices to which the manager is compared, but be careful of using past performance to invest for the future. So, if you shouldn’t chase the unicorn, what should your goal be?
To be average!
Be the market. Focus your research on the cost of investing (fees and commissions), your personal allocation strategy, building a strong overall financial plan and keeping a tight rein on risk. With this in mind, what is your best strategy?
There is absolutely no one-size-fits-all strategy, but there is one strategy that has helped millions of investors overcome their own behavior and the foolishness of picking and timing stocks.
It’s called passive investing.
Today’s passive investors enjoy the opportunity to create customized and easy to manage portfolios with low cost, diversified index mutual funds or exchange traded funds; portfolios that range from simple to complex, and may include everything from the most common of common stocks to sector plays as narrow as commodities, marijuana and cryptocurrency.
Passive portfolios will satisfy the risk and return objectives of any investor, providing proper diversification, low costs and high tax efficiency.
Because of this, the passive investing community continues to grow, and the active management industrial complex continues to be concerned.