Tuesday, June 17, 2008

Your Own Worst Enemy

Jim Parker, Regional Director, DFA Australia Limited, June 2008

It's a difficult pill for many of us to swallow, but sooner or later we need to realise that the biggest obstacle to enjoying investment success often is not the market itself, but our own behaviour.

This tough lesson about investment is never more important than in the volatile markets we have seen in the past year. It is at these times, more than any other, that people tend to make dumb mistakes.

Those mistakes include neglecting to diversify, failing to track expenses and ducking in and out of the market in counter-productive attempts to miss the worst of the losses and capture the sweet spot in the rebound.

The fact is that as fallible human beings we tend to over-rate our own abilities and imagine that we can see things that others can't. In an extremely competitive arena such as the financial markets, this can be ruinous.

Just how ruinous poor individual judgement can be to your financial health is revealed in a newly updated annual quantitative analysis of investor behaviour by the US financial services research group Dalbar.1

That latest survey, covering a two-decade period, echoed the findings of previous surveys—that returns are far more dependent on investor behaviour than on fund performance and that most fund investors who buy and hold typically earn higher returns than those who try to time the market.

In the 20 years to December 31, 2007, the average US equity fund investor would have earned an annualized return of just 4.48 per cent, Dalbar found. This was more than seven percentage points below the return of the S&P 500 index and less than 1.5 per cent over the inflation rate.

Fixed interest investors would have fared even worse. Their average annualized return over the same period was 1.55 per cent, below the index return of 7.56 per cent and not even keeping up with inflation. In other words, the average fixed interest investor went backwards over that time.

Dalbar concluded that investor returns are markedly different from the returns promoted by fund managers because most people try to time their entry and exit points—and often get it wrong. Secondly, the holding periods of individual investors tend to be shorter than those of fund managers.

Interestingly, the survey also found that investors are more likely to make 'correct' timing decisions when the market is going up. Correspondingly, they are more likely to mess things up when the market is down.

In other words, most people fail to exercise patience in tough markets. The consequence is they fail to secure the rewards available to them.

It seems that you really can be your own worst enemy.

1Quantitative Analysis of Investor Behaviour, 2008, Dalbar

Monday, June 09, 2008

Give me the luxuries of life...

From The Writer's Almanac with Garrison Keillor: (LISTEN to this newsletter)

It's the birthday of architect Frank Lloyd Wright, born in Richland Center, Wisconsin (1867). He believed in designing houses that were in harmony with their environmental surroundings and said, "No house should ever be on a hill or on anything. It should be of the hill. Belonging to it. Hill and house should live together each the happier for the other."

The houses he designed were usually low to the ground, hugging the earth, with a large fireplace and a small kitchen. Often, instead of interior walls, he would use furniture to separate living spaces. He loved to use glass and incorporate lots of natural light. In his early homes, his glass windows featured geometrical designs and colored lines; in later models, when technology allowed working with large sheets of glass, he would sometimes replace whole exterior walls with glass. He also took special care in designing carpets, choosing geometric patterns that were played a significant role in the floor plan.

Late in his career, he turned to commercial projects - including designing furniture and creating wallpapers, carpets, and paint colors for major American companies. He also designed model homes that were featured in Life magazine and Ladies Home Journal.

He once said, "Give me the luxuries of life and I will willingly do without the necessities."