A winning investment strategy

October 2011, The Profit

News, like the share markets can be unpredictable.  The recent volatility in the markets has demonstrated this, but that’s the way financial markets operate – they have periods of both downward and upward movements. 
 
Volatile markets can be an emotional rollercoaster for some investors and can bring a range of familiar emotions to the surface, including a strong urge to try to time the market.  The temptation, as always, is to sell into falling markets and buy into rising ones.
 
Investors who are perceived to be "well-informed" - those who regularly monitor the financial papers - are the ones who feel most compelled to try and time their exit and entry points.
 
The suspicion that "sophisticated" investors are the most prone to try and outwit the market was given validity recently by a study, carried out by London-based Ledbury Research, of more than 2,000 affluent people around the world.
 
The survey found 40% of those who were questioned admitted to practicing market timing rather than pursuing a buy-and-hold strategy.  Interestingly, the market timers were more than three times more likely to believe they traded too much.
 
"On the face of it, you might think that those who were trading more actively would be more experienced, sophisticated and able to control themselves," the authors said.  "But that seems not to be the case - trading becomes addictive."
 
These behavioural issues and how they impact on investors are well documented by financial theorists.  Commonly cited traits include lack of diversification, excessive trading, an obstinate reluctance to sell losers and buying on past performance.
 
Mostly, these traits stem from over-confidence.  We all tend to think we are above-average in terms of driving ability and we also tend to over-rate our capacity for beating the market. This ego-driven behaviour has been shown to be more prevalent in men than in women.
 
A study quoted in The Wall Street Journal showed women are less afflicted than men by over-confidence and are more likely to attribute success in investment to factors outside themselves – like luck or fate.  As a result, they are more inclined to exercise self-discipline and to avoid trying to time the market.
 
What often stops investors getting returns that are there for the taking are their very own actions - lack of diversification, compulsive trading, buying high, selling low, going by hunches and responding to media and market noise.
 
So how do you remove egos and emotions from the investment process?
 
One way is to create some distance from the daily noise generated by the media and work with an adviser that focuses on your long-term interests.
 
Whilst there are things you can’t control (such as the ups and downs in the markets), an adviser will show you there are things that you can control.  This includes ensuring your investments are properly diversified - both within and across asset classes, ensuring your portfolios are regularly rebalanced to meet your long-term requirements, keeping costs to a minimum and being mindful of taxes.
 
And of course, remaining focused and disciplined – particularly in times of adversity when markets are volatile.  Ultimately, discipline is the way to building long term wealth and a winning investment strategy
 
 
Data Sources:
Dimensional Fund Advisors June 2011
Risk and Rules: The Role of Control in Financial Decision Making', Barclays Wealth, June 2011
Barberis, Nicholas and Thaler, Richard, 'A Survey of Behavioral Finance', University of Chicago
'For Mother's Day, Give Her the Reins to the Portfolio', Wall Street Journal, May 9, 2009
 
Disclaimer
“The opinions expressed in this article are those of Stewart Group’s advisers and should not be considered as advice. Investors should obtain professional advice regarding their own financial circumstances and objectives before making any investment decision.  Under the Financial Services Act 2008 a copy of our Disclosure Statement is available on request and free of charge."