Sensible dollars

Are You a Smart Investor or Just Lucky?

By Allan Kunigis

Allan Kunigis is a Canadian-born financial freelance writer based in Shelburne, Vermont. He has written about personal finance for more than two decades. His A Kid’s Activity Book on Money and Finance: Teach Children about Saving, Borrowing, and Planning for the Future was recently published.

So, you picked an investment that did really well last month or year. Congrats! But was it skill or luck? Could you do it again? And again?

This is an age-old question in the world of investing: Was that one good investment performance a result of you being that good or just that lucky? Whether a single stock or a mutual fund that you bought, or a portfolio that you held for a period of time that performed better than the investment markets, was it skill or luck?

The honest answer is it might be really hard to say. Could you do it repeatedly? Or is your long-term performance as an investor likely to “revert to the mean” or regress to the average over time? Think of the law of averages. How many times in a row could you flip a coin and get “heads?”? Maybe five or six? Perhaps seven or eight? Now try it 100 times. You’re likely to get results that are pretty close to 50-50.

THE AVERAGE PROFESSIONAL INVESTOR TRAILS THE STOCK MARKET

Numerous studies have tracked how well the averagemutual fund, managed by a team of professionals,performs over time against a well-known benchmark,such as the S&P 500 Index. The sad news is that the average mutual fund does not outperform itsbenchmark – the index that the fund compares itsperformance against.

That’s partly because of the costs of running a fund,trading stocks and bonds after researching them andpaying for all of the fund’s overhead. Incurring those costs every year means that in order to do better than a benchmark that doesn’t carry those costs, your fund would need to make up for those costs andthen perform that much better yet.

For example, if the annual costs of running the fundmake up 1% of the fund’s assets, if the index you’re measuring your performance against gains 10%, yourfund would need to earn 11% per cent to break even.

In this study, “92% of Canadian equity funds underperformed their benchmark in 2019 and 86% underperformed over the past decade.”

Historical returns show that it’s hard. In 2019, forinstance, just three in 10 U.S. stock funds beat theirbenchmark index, according to Barron’s. Canadian stats are even worse. In this study, “92% of Canadianequity funds underperformed their benchmarkin 2019 and 86% underperformed over the past decade.”

But surely some investment managers are better than others, right? They can beat the market again and again. It’s true that over the years or decades, some legendary fund managers have done better than others. But even they are going to have some bad years. They make mistakes or their investment style falls out of favour.

But let’s get back to you. Just how good are you? Do you know more than the market? How? How do you know more than the pros?

I don’t know you and I don’t want to insult you, but study after study shows that average investors actually do appreciably worse than the overall stock market. One key reason is that they trade too often. The more you trade, the more expenses you incur and, more importantly, the more mistakes you can make.

AVERAGE INDIVIDUAL INVESTORS TRAILED THE S&P 500 BY ALMOST 6%

Dalbar, a highly regarded investment industryresearch firm, published a study that showed thatthe average stock mutual fund investor trailed theS&P 500 Index by 5.88% over a 30-year period endingDecember 31, 2018.

Ouch! And these are people entrusting theirdecisions to a team of pros. And you think you knowbetter than the professionals? Hmmm…

I don’t know you and I don’t want to insult you, but study after study shows that average investors actually do appreciably worse than the overall stock market. One key reason is that they trade too often.

Another tidbit is that males often trade morethan female investors – and do worse!. TerrenceOdean and Brad Barber, a couple of academics atthe University of California at Berkeley, publisheda famous study entitled “Boys Will be Boys:Overconfidence and Common Stock Investments.”In it, they determined that among more than 35,000households using a large discount brokerage in theearly to mid-1990s, men traded 45%% more thenwomen, and “trading reduces men’s net returns by2.65 percentage points a year as opposed to 1.72percentage points for women.”

More recently, in a 2017 study, Fidelity Investmentsfound that women outperformed men by 0.4% a yearon average even though men are more likely to thinkthey’re better-than-average investors. In contrast,only 9% of women investors think they’re better thanmen.

WISDOM FROM WARREN BUFFETT

I think we can all learn from a truly superior investor,Warren Buffett, whose net worth is an estimated $86 billion U.S. He amassed that wealth through hard work, humility, sober analysis, and by buying shares of companies that he believed in and that he assessed as “undervalued.” Over the decades, he ha sbought shares of companies, sometimes at bargain basement prices, and held onto them for years. Not very sexy, but highly successful.

As quoted in investopedia, Buffett said, you don’thave to be a genius “to invest successfully overa lifetime. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”

You might not be as smart or skilled as Buffett, butyou might learn from his humility, discipline, and long-term perspective. The next time you think you know of a hot stock or trend that you want to cash in on, remember these Buffettisms:

• Our favourite holding period is forever.

• Risk comes from not knowing what you’re doing.

• You only find out who is swimming naked when the tide goes out.

• Someone’s sitting in the shade today because someone planted a tree a long time ago.

If I can throw in a Kunigisism: Sometimes slow and steady – and humble – wins the race.

FOOTNOTES:

1: https://www.barrons.com/articles/if-you-still-ownactively-managed-stock-funds-get-ready-for-somebad-news-51579691701

2: https://www.evidenceinvestor.com/92-percent-ofcanadian-funds-underperformed-in-2019/

46 SIDEONE DECEMBER 2020