Investments Versus Investors: Don’t Fall Into That Yawning Chasm

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In the wake of the dire market crash of October-November 2008, many analysts have talked about investments and investors – almost as though the two words are synonymous.

But they’re not. In my experience, there’s a dramatic gulf between “investment performance” and “investor performance.” The former has to do with markets; the latter has to do with human behaviour, which is tricky and unpredictable.

Let’s talk first about investments. We’re often drawn to stocks based on their past performance, which we hope will predict their future performance. For example, in 1946 the S&P500 stock index stood at 19 points. Today, it’s 1950 points. That means an investor who put $10,000 into the S&P500 back then, and re-invested dividends ever since, has about $1,950,000 today. That sounds pretty good, an impressive history.

The problem is, though, that investors are often too jumpy to hold on for the long term. They tend to buy stocks when things look good, and sell them when things look bad.  

Investors typically pile into stocks when times are good, and then abandon them when times are bad. This only has to happen once or twice to create the yawning chasm that exists between investment returns, and investor returns.

One expert who’s analyzed this phenomenon is Jeremy Siegel, in his book Stocks For The Long Run. He points out that annual returns on stocks are actually far more consistent than returns on treasury bills – provided you’re willing to measure over 20-year periods. The market returns on large-cap U.S. stocks are approximately 10.8%, compounded every two decades over the last 200 years.

But that 10.8% is way, way bigger than the return most investors receive over the long haul. Dalbar, a Boston financial research firm, estimates that investors earn only a little over 3.5% over a similar time frame. As you can see, there’s a big difference between the two numbers. Where does the other 7.3% go?

We’ve all heard the simple adage “buy low, sell high.” Unfortunately, it’s easier to repeat than it is to actually follow. Consider the awful experience of late 2008, one we’re still feeling the effects of. The world’s financial system was brought to a near collapse by a credit crisis that no one really saw developing – a crisis created in the boardrooms of financial institutions around the globe. The fall in real estate prices was the catalyst for the eventual collapse, which brought banks and even governments to their knees.

In that kind of environment, you might well have nervously wondered: “Should I hold onto my stocks, or sell out?” Most investors answered in the negative. They voted with their feet and sold out of equity markets, likely close to the bottom. Some, though not all, may one day buy back their investments – probably for above-average prices.

The pain investors feel in response to wildly gyrating markets is very real. For those who rely on their investment returns for income, such as retired people, these are difficult days indeed. In such times, it’s completely normal to feel insecure and depressed about your investments – and completely inadvisable to actually act on those feelings.

Just tell yourself firmly that the world has been through financial crises before – and has always recovered. Think back to WWII, or the Cuban missile crisis of 1962, with its threat of imminent nuclear annihilation. Yet if we look at average stock returns since those traumatic times, they’ve been just as usual: 11% compounded. The market is like a ship that always rights itself, even though panicked investors may already have thrown themselves overboard.

Consider one of the smartest guys in the financial world: “the Sage of Omaha,” Warren Buffet. Back in a 45-day period in July and August 1998, Buffet – like many others – was caught in an extreme market turndown. On paper, he “lost’ more than six billion dollars. Except he didn’t actually lose a single dime: he just held tight to his investments, and waited for the market to correct itself – which it did.

Alan MacDonald an Investment Advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of "The Copperjar System, Your Blueprint for Financial Fitness" available on Amazon.

For more information please visit www.alanmacdonald.ca or email Alan at Alan.Macdonald@RichardsonGMP.com.

All material by Alan MacDonald, Investment Advisor at Richardson GMP Limited. The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP or its affiliates.

Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.

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