Whether individuals are simply seeking to grow their savings or manage their own pension pots, many investors attempt to reach their goals by investing themselves rather than using the services of a professional. But is this sensible or effective?
While it’s undeniable, especially in the Middle East, that there is huge importance attached to ensuring you work with the right investment professional, the evidence shows that investment returns generated by professionals consistently outperform returns by the average equity investor.
Why does this happen? One factor is that emotional decision making clouds the judgment for investors leading to poor investment decisions. Here we take a look at a number of ways in which investors hinder their own performance by behaving irrationally.
One prime example of emotional investing is the very expensive and typical UAE savings plans. The redemption value is often a fraction of the money paid in, however, investors who need to raise cash, would rather sell a strong performing investment than liquidate this poor performing investment i.e. displaying irrational behaviour by having “regret” about the investment decision but being unwilling to do anything about it. This is a standard behaviour trait of most individual investors and as a result, they tend to hold losing investments and sell profitable investments.
Investors are heavily influenced into buying investments that have gone up in the past and avoiding investments that have lost in the past, which reinforces the buying decision but results in having undiversified portfolios which become more at risk to changes in the market.
Another key factor that influences the investor is what they read online and hear on the news. As a result, they tend to sell when fear is persuasive and buy when the news is positive, which has been evidenced to result in underperformance.
The country the investor comes from or intends to retire to has an impact, and as a result, they tend to have portfolios that are far from being diversified. They end up creating unnecessarily concentration by holding a lot of assets or investments in that country, which by nature has a higher risk.
The behaviour or actions of friends and colleagues also influences investors. This type of herd mentality is natural behaviour when making big decisions, but not necessarily one that results in positive outcomes for them, with people often overlooking logic for familiarity. We see regular examples of this in the UAE with individuals investing in expensive poor performing savings plans without research because a colleague has recommended the adviser and done the same.
Investors and advisors tend to buy using a rear-view mirror instead of buying with a forward view. i.e. they buy with a hope that they believe “what will happen” (tendency bias) assuming that the past is an indication of the future. They then sell after an event has actually happened (capitulation) or they sell to lock in a gain rather than due to the belief that the past winner is a future loser.
Ultimately statistical performance returns shown are purely academic, in the real world it is different. Investors and advisors trade often, incurring unnecessary costs and often have poor asset selection ability and top it off, they often have a high concentration of risk. The real risk-adjusted returns come from well-diversified low-cost portfolios.
An experienced and accomplished advisor would carefully assess the risk and return of all possible investment opportunities, create a portfolio that would suit the client’s risk profile and long-term goals, rather than what the client thinks is low risk or exciting. In this instance, the most likely result will be the client’s expectations being dashed but without emotion dictating investment it should also result in a better long-term investment plan for the individual.