The Fault, Dear Investor, is Not in Your Investments, But in You

Consider these statistics.

• The average commercial aircraft flies at an altitude of thirty-five thousand feet.
• The average passenger in a commercial aircraft flies at an altitude of twenty thousand feet.

“How can this be?” you may be wondering.

Well, as Mark Twain said, “There are three kinds of lies: lies, damned lies, and statistics.” And the stats I shared above are not a lie, they are just made up by me. And they do sound foolish.

Anyways, now consider these statistics.

• Over the last twenty years, the average equity mutual fund posted a yearly return of 8%.
• Over the last twenty years, the average investor in an equity mutual fund posted a yearly return of 4%.

These numbers are not made up but come from a study conducted by the US-based investment research firm Dalbar, and are for US-specific funds.

Now, there are people who argue that the Dalbar study is flawed as it may be incentivized by the financial advisory industry. Why? So that they can point fingers at the average investor, telling him, “See, you can’t invest on your own because Dalbar says you can’t, and so you must seek help from advisors.”

In fact, noted WSJ columnist Jason Zweig has even tweeted – “The new four most dangerous words: ‘Read the DALBAR study.’”

But without getting into the authenticity of Dalbar’s or anyone else’s study on how dumb investors are (though we are not as dumb as such studies suggest!), you may want to agree to one point. It is that a majority of investors play the short-term game – trading in and out, in and out – with everything that is equity – stocks and mutual funds – an asset class that has been known to build wealth over long periods of time. And that is why a majority of investors earn lower returns compared to even the market’s average return.

As per data from the Indian mutual fund regulator AMFI, about 54% of investors in equity funds stay invested for less than 2 years.

The tendency – of short-termism – has become more common over the years. This is given that the number of funds has exploded and information about them has increased in availability.

Investors, who are have become so used to chasing short term performance, are acting a lot more with the vastly available information on how funds perform not just year on year, but even on a quarterly and monthly basis.

This would not matter if investors were able to time their entries and exits well. That is, they were able to switch into funds that would perform better than the ones they switched out from, and at the right time. But ‘perfect timing’ is a utopian concept in investing.

While chasing the leaders, we ignore the concept of regression to the mean, which is like saying that in any event where luck is involved (like investing), extreme outcomes (like market outperformance or underperformance) are followed by more moderate ones.

Now, in no way I am suggesting that you must stick with your losing funds forever, as people do with their losing stocks to get their money back. What I am suggesting is that instead of switching in and out of funds, you must give time to the ones that have been managed well in the past but may just be going through a temporary period of underperformance vis-à-vis the new leaders.

This is exactly what you must do with your losing stocks. Stick with businesses that have been managed well in the past, and even now, even when their stocks are going through a temporary phase of a downturn owing to the overall market weakness.

“Investing is simple, but not easy,” says Charlie Munger. Knowing that following the herd or chasing market leaders is a way to hell is the ‘simple’ part. Avoiding it is the ‘not easy’ part.

Trying to time the market or finding winning stocks or fund managers and then siding with them till you find the next batch of winning stocks or fund managers is a waste of time that often backfires.

To do well over the long run, your best bet is to keep things simple. Stick with stocks, funds, and managers who are intrinsically good, even when they are going through temporary bad phases, do not deviate from your investment process, minimize your costs, and keep a long-term perspective.

Cassius, a Roman nobleman, uttered this phrase when he was talking to his friend, Brutus, in Shakespeare’s play Julius Caesar –

The fault, dear Brutus, is not in our stars, but in ourselves…

This is true in investing too.

And so, you must learn to manage yourself well, for then managing your investments would not be a tough ask.