With daily news stories painting a bleak picture of the economic times to come, you may be thinking it’s time to put your money into something ‘safer’ than the share market. Maybe a term deposit with a bank would be better, you wonder, because at least you wouldn’t have to worry about losing your hard-earned savings and constantly check how they’re performing.
If thoughts like these are living in your head, you’re not alone. In fact, they’re perfectly natural concerns shared by many investors. The problem is, they’re exactly why the average investor ends up earning considerably less than the share market returns over time.
No-one can see the future with absolute certainty, but we can look back to learn and do better in the future. Here’s what our investment advisers know about the share market and investor behaviour.
Share markets run ahead of the economy
At the first sign of possible economic challenges, shares start to drop in value. By the time the economy has actually declined, share prices are already low. Conversely, as soon as it looks like the economy might start to improve, share prices immediately climb in anticipation. This typically begins well before the economy actually improves.
Many investors buy when share prices are high
Driven by a fear of missing out (FOMO), most ordinary investors see share prices rising and hesitate to make sure it’s not just a blip. Then, as prices continue to rise and reward those who bought in earlier, they want in. But soon after they buy the cycle peaks, and then prices start to go down.
Many investors sell when share prices are low
As share prices begin to fall, most ordinary investors start to feel nervous. If they bought high, the shares can soon be worth less than they paid. As the values continue to fall they begin checking prices almost daily hoping for a positive sign. Before long the strain is too much. They lose faith in the market and decide to cut their losses before things get any worse. The problem is, the share prices soon begin to rise once again.
Many investors over-estimate their ability to predict trends
Overconfidence is a common human trait. We see it everywhere. Most new business owners believe they will be successful, but less than half typically are. Similarly, many ordinary investors over-estimate their ability to predict share market shifts and they engage in short-term tactical trading to their regret.
Ordinary investors’ gains are much less than markets return
The above behaviours are reflected in the relatively poor returns average investors achieve. Research by USA company Dalbar Inc showed that in the 20 years to the end of 2019, the S&P 500 Index had an average return of 6.06% p.a., but the average equity fund investor only earned 4.25% p.a. Their research also showed that in the 30 years to 2016, these returns were 10.16% p.a. and 3.98% p.a. respectively. Over this 30-year period, a $100,000 investment in the S&P 500 Index gained more than $1.8 million, but the average equity fund investor only gained $322,474.
So what should investors do to get better returns?
Everyone’s situation is different and it’s important to get experienced financial advice before making decisions. In the meantime, here are some widely accepted general principles for investing.
- Try to remove emotion from decisions – working with an investment adviser can help with this
- If you have concerns, review your financial plan to see if anything has really changed; if your goals remain the same, it’s likely the best option is to stay calm and carry on
- When prices are low, look for quality shares to invest in
- When prices are high, consider moving some funds into more stable (low risk/low long-term return) investments (like a term deposit), especially if you’re nearing a time when you may be requiring more cash
- If a dip in share prices has kept you awake at night, it may be time to review your risk appetite and financial plan, then adjust your investments when values improve
If you have concerns about your investments or are ready to start investing for your future, we’re here to help. Our experienced investment advisers can work with you to develop a financial plan that suits your needs and a strategy for taking action. To learn more, please contact us today.