Maybe it's not the market... maybe it's you

If you're like most investors, chances are you're underperforming the market. Why is that and what can you do about it?

Minus 1.2%.

That's how much investors underperformed the share market each year over the last decade. 

According to Morningstar, US share market investors earned an average of 12.0% a year, during which time the US share market returned an average of 13.2% a year (as measured by the S&P 500 Index). 

The shortfall was largely due to poorly timed buying and selling by individual investors. This earned them much less than if they had simply bought and held their investments. 

This isn't just a US problem. New Zealanders who invest in managed funds or KiwiSaver schemes are also guilty of this behaviour. Our human psychology is to blame. We're prone to overconfidence and vulnerable to herd mentality. When markets rise strongly and everyone's making money, we convince ourselves this time is different. Fearful of missing out, we pile on in, even though valuations might be getting stretched. 

Behaving like this can even be logical. For example, even if you believe a fund is highly valued, it can still make sense for you to buy in if you also believe you can sell out again soon for more money. You simply pass your hot potato along the line. Everything works out, so long as the band keeps playing.

But at some point, the music stops. People stop buying and they start selling. Your fund falls, you get spooked, and you sell out or switch to a lower risk fund. This behaviour is driven by loss aversion. It happens because we dislike losses much more than we like gains. We become willing to sell at a loss, just to potentially avoid more losses.

Yet why did you invest in the first place? Because the price was rising? Remember, this is the opposite of what you normally do. Usually, you buy more of something when its price falls, not when it rises. 

However, we feel very differently about the price of assests versus the price of other things. And it's because of this bias that the economic situation today presents opportunities for those who have the means and conviction to seize them.

History confirms this. From 1928 to 2021, the US share market (the world's largest), has had 26 'bear' markets, where the market (as measured by the S&P 500 Index) has fallen over 20%. On average, these have occurred every 3-4 years, lasted around 10 months, and shares have fallen about 36%. This sounds bad, but the good news story is much stronger. 'Bull' markets, where a share market rises by more than 20%, tend to last longer (around 33 months) and not only recover losses but also grow strongly. For example, following the Global Financial Crisis, the US share market rose by over 400% from March 2009 through to February 2020. It then fell sharply due to the outbreak of COVID-19 but recovered strongly in the fastest rebound in history.

It's important to take this longer-term view, as we humans tend to overweight the importance of information that's recent and negative. It's easy to forget that over the past 30 years, world poverty has fallen and share markets have risen. Today's headlines of bear markets, inflation, and war in Europe can be too salient.

Whenever negative news tempts you to fiddle with your investments, remind yourself that on average, share prices rise much more often than they fall. Historically, shares have clocked annual price gains around 75% of the time. So, if you're betting on shares to fall, odds are, you're wrong.

So what should you do?

If you want to come through this downturn in a stronger financial position, you have two options: 1. – to master your emotions; or 2. – to outsource them. 

1. Master your emotions

Firstly, try to separate your emotions from your investing. Ignore sensationalist articles about market crashes and take a multi-decade view instead. Remind yourself that volatility is normal, that share markets have risen on an annual basis around 75% of the time, and that people who try to time the market most often lose. 

Then, ensure that your KiwiSaver fund choice is aligned with your investment timeframe and risk profile. For example, if you don't need to spend money for 10 years or more, consider a growth fund. This type of investment carries more risk but can reward you with higher average returns over time. When markets become choppy, remind yourself that you don't need the money today, and can handle a bit of volatility to achieve better performance in the long run.

Lastly, put your investing on autopilot. Use our calculator to get an illustration of how much you may need to save to reach your first home or desired lifestyle in retirement and adjust your contribution rate to achieve it. Then forget about your KiwiSaver investment, only reviewing your fund and performance once a year.

All of this sounds simple, but for most people it isn't. Often, it's just too hard to separate yourself from your money. If this is true for you, don't be disappointed and instead consider option 2. 

2. Outsource your emotions

Getting professional financial advice can greatly improve your financial outcomes by helping you to understand your goals, set a plan, and choose the right KiwiSaver scheme fund. Even more importantly, the value an adviser can bring is to help you stick with your plan, through good times and bad.

Having an expert between you and your money helps ensure you don't make irrational decisions that could set you back years. This happened to thousands of Kiwis during the COVID-driven market sell-off. According to the Financial Markets Authority, over 60,000 people switched KiwiSaver scheme funds during March 2020, mainly from higher risk, higher return funds to lower risk, lower return funds. Instead of sticking to their goals, these people let their emotions get the better of them. By the time the market recovered in August that year, over 90% of these people were still in lower risk funds, effectively locking in their losses. 

Don't become one of these people. As a MAS Member, you have access to a network of commission-free MAS Advisers based all around New Zealand. They're here for your benefit, so please do your future self a favour and get in touch. 

Do something today

Markets go up and down over time. It's ever changing and the damage is temporary. But the damage you can cause by letting your emotions get the better of your investing is permanent. Learn to master your emotions quickly or call a MAS Adviser today on 0800 800 627.

Jules Riley

Senior Growth Manager, Investments, MAS