Pessimism's Tax: What It's Really Costing Your Investment Portfolio
Investors are their own worst enemies.
Their behavior destroys their portfolio’s performance more than the investments that they pick.
You will probably read those first few lines and feel you are the exception. You may be surprised.
There is a company that does a great study every year that looks at the returns of the average investment fund. These funds have consistently delivered an average annualized return of 10-11%, around the long-term average returns of stocks.[1]
The 2nd part of the study looks at the average return of each one of the investors in those funds.
A whopping 5%.
That is ~50% less than the ACTUAL performance of the funds they were in. This was not a miscalculation of what investment to pick, it was merely a lack of realizing the returns that the investments offered.
If you are an investor that has a 20-year timeline, this could mean the difference of having almost half the amount of money come retirement.[2]
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What a costly mistake.
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It is hard to put a finger on a single variable here.
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However, I can assure you that a big part of this performance gap – or “behavior gap” – is investor pessimism.
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Investor pessimism is so costly.
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Why is it that the stock market has been a phenomenal way to grow wealth over the last several hundred years but there is so much pessimism?
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It is quite impressive how long the stock market has been around and the returns it has returned consistently to investors.
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Consistently only if you are disciplined in your strategy and behavior.
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Historically, the odds of losing money in a diversified stock portfolio over most 20-30-year periods are very low.[3]
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But why is it that at any point in time, all your neighbors and financial journalists feel like we are on the brink of collapse?
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Worrying about market crashes strongly affects decision-making. But man, what an expensive mistake.
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The great Peter Lynch once said something like, “Far more money has been lost by preparing for corrections than corrections themselves.”
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Several behavioral finance studies show investors think the likelihood of a correction at any given time is magnitudes higher than even the historical probability.
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Humans thrive off pessimism.
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When financial journalism has a negative outlook on the market it has a great effect on how investors make portfolio decisions.
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Bad market outcomes also have a disproportionate amount of coverage.
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However, when financial journalism is positive about current events it hardly affects investor outlooks, they remain the same.
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Again, humans thrive off pessimism.
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The cost of pessimism is you miss out on returns. Even missing 1-10 days can have a substantial impact on wealth.
Long-term disciplined investors have been rewarded over time with an incredible wealth-generating tool.
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But you must stay invested to capture these returns consistently.
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Here are a few things that you can do to help with pessimism and your investment accounts.
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1)??? Look at your accounts less frequently.
2)??? Minimize the amount of financial media you take in.
3)??? Improve your financial literacy and knowledge of markets.
4)??? Delegate your investments if you feel you may get in your own way.
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It is important to be honest with yourself. Have you made emotional investment decisions before?
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If you are constantly in and out that answer is probably yes. It is hard to measure the cost but based on the real-world examples I have seen it is costly.
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If you have had the same investment strategy for 20 years and you have matched basic market returns, then you are probably doing a good job.
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Market crashes are painful. They affect how we make future decisions.
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I am not advocating for 100% stock exposure and do nothing else.
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I advocate for a good strategy that is built to not only handle market volatility but also your pessimism that will come up now and then.
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?Drew Lunt
Scratch Capital
208-901-8018
Disclosures and Sources
Advisory Services are offered through Scratch Capital LLC, an Investment Advisor in the State of Idaho. All content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. Nor is it intended to be a projection of current or future performance or indication or future results. Purchases are subject to suitability. This requires a review of an investor’s objective, risk tolerance, and time horizons. Investing always involves risk and possible loss of capital.
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[1] https://www.dalbar.com/ figures in the article are rounded.
[2] Ex 1: PV $0, I 10%, n 20, PMT $25,000, FV = $1,431,874.99. Ex 2: PV $0, I 5%, n 20, PMT $25,000, FV $826,648.85
[3] https://my.dimensional.com/login Global Equity Index, 225 rolling 30 year periods since 1975, positive 100%
Absolutely, your insight reminds me of Warren Buffett's wisdom, "The stock market is designed to transfer money from the Active to the Patient." ?? Patience and positivity in investments often lead to growth. Speaking of growth, Treegens is sponsoring an initiative for the Guinness World Record of Tree Planting. It's a great opportunity for involvement and investment in our planet's future. ?? Check it out: https://bit.ly/TreeGuinnessWorldRecord
?? Absolutely insightful perspective! Warren Buffett once said, "The stock market is designed to transfer money from the Active to the Patient." Keep focusing on the long-term vision, not just the temporary dips. ?? Keep thriving! #InvestmentWisdom
Retired
1 年Excellent again Drew. Thank you. Appreciate the advice.
Dry Etch Process Engineer at Micron Technology
1 年Great read Drew! I liked your first suggestion to battle financial market pessism: just look at your accounts less often. If you’re sticking to the plan you implemented with a clear head, there’s no reason to be constantly checking the number.