Disappointing investment performance over the past few years has resulted in many investors starting to question the ability of the market to deliver on their long-term goals. In response, investors often try to correct for weak returns by making changes to their portfolios. Unfortunately, the reasons behind their desire to change are often emotionally driven, and are prone to error, which can lead to greater loss. To improve our chances of achieving success in our financial goals, we aim to understand what we can and cannot control and divert our efforts to “controlling the controllables”. This is especially true during the current market environment.
Let’s consider our current market environment for a moment. By the end of 2018, the average investor’s portfolio1 had underperformed a cash investment for five years. This is illustrated by point 8 on the graph below, where the five-year return on a typical retirement fund crosses the five-year return of an investment in cash. In other words, with perfect hindsight, an investor would have been better off invested in a fixed deposit over the past five years than in a typical retirement fund. Many investors have now sought to counter this through using cash investments, or similar low risk alternatives, in place of a growth oriented portfolio Alternatively, they have avoided making new investments completely.
History provides us with some useful perspective. Firstly, we can see that investment returns do sometimes fall below cash. This has happened eight times over the last fifty years (see points 1 - 8 above). Secondly, we see that periods of weak performance ar followed by periods of strong performance (points 9 - 14 above). And lastly, recoveries tend to happen rather quickly. The question we should be asking is not whether the market will recover, but rather how long until it does.
The problem we face is that many investors are responding to the weak performance in the markets by switching their investments to cash – but only after experiencing four years of weaker returns. This is a typical behavioural bias driven by fear and loss aversion tha results in “selling low”, i.e. after prices have dropped. Similarly, investors tend to miss out on some of the recovery by switching back into the market at higher prices, i.e. “buying high”. Research studies2 have shown that an investor’s buy and sell decisions cost them on average 2.9%3 per year in return foregone, relative to investors who hold on to their investments and resist the urge to change.
On this basis, the patient investor retires with 60% more capital compared to the impatient investor!
The example above shows that we certainly don’t have control over market performance and our reactions generally result in greater loss. So where does our circle of control begin and where does it end? We answer this question in the table below with some practical mitigation in dealing with the risks which fall outside of our control.
Many of the uncontrollable forces that affect our portfolios can indeed be managed if we focus on what we can control first: By managing our personal finances, by implementing a sensible financial plan and by controlling costs. Within each of the “controllables” here are simple steps to follow to ensure we remain disciplined in managing our financial affairs:
The temptations we face in investing are numerous, often expensive, and never obvious. If you feel that any of the decisions you intend making are in response to the events we refer to above, it may serve you best to do nothing. Capital preservation, financial discipline and a healthy dose of patience will ensure that the longer term investing goals remain on track.
 The portfolio of a typical long-term investor saving towards retirement.
 Dalbar releases an annual report that shows the impact of investor’s decisions on their portfolio performance.
 Based on the 2017 Dalbar study, annual underperformance over last 20 years.
 Based on a 2.9% annual cost due to making changes, over a thirty-year investment horizon from age 30 to 60