We are all a little bit crazy; or at least a bit irrational. While logic would predict that humans would behave… well… logically, human nature is far less predictable. Take for example our eating habits. We as Americans are chronically overweight, but it is not for lack of information or knowledge on how to eat better. Despite all of the information in our head, we too often reach for the ice cream in the fridge instead of the broccoli. Why? Because in the moment, it is emotionally difficult to choose the broccoli.
It is important to remember that investing is done by humans. It helps explain why the financial markets, despite being very quantitative, can also be quite irrational. In practice, we all know we should buy an investment when it has a low price, and sell it when it has a high price. And yet, executing that decision is emotionally difficult in the moment. As a result, our emotions can be one of our worst enemies. According to the 2014 release of Dalbar’s Quantitative Analysis of Investor Behavior, the average investor in a blend of equities and fixed-income mutual funds has garnered only a 2.6% net annualized rate of return for the 10 years ended December 31st, 2013. These results compare with 7.4% for the S&P 500 and 4.6% for Bonds.
The average investor actually trails the market because the average investor tends to sell and buy at the wrong times, buying when times are good and prices are high and selling when times are bad and prices are low. As Daniel Crosby, Psychologist and expert on investor behavior says, “Most people assume that economic conditions, timing, investment acumen, etc. are the most important aspect of investing. However, study after study shows that we are our own best friends and worst enemies in the market. That message is simultaneously empowering and burdensome, because we are in control to a larger degree than we’d previously expected.”
So what is the upside of crazy? If markets are even a little bit irrational, it provides opportunities for those with discipline to do better. By employing a methodical, disciplined, cash-focused approach to investing, there is upside to those who can master the emotions of fear and greed. A big part of what we do as professional investors is bring that discipline to our decision process to find the upside of crazy.
Hanlon, Sean. “Why The Average Investor’s Investment Return Is So Low.” Forbes. April 24, 2014. http://www.forbes.com/sites/advisor/2014/04/24/why-the-average-investors-investment-return-is-so-low/.
Schulaka, Carly. "Daniel Crosby on Investor Behavior, Why Planners Need Planners, and the Upside of Crazy." Journal of Financial Planning. July 2015.