«It pays not to take your feelings so seriously. It is better to look the other way.»
Invest Regularly – Even After Losses
When investing, the mood swings with portfolio performance. This is very human, but unfortunately completely wrong for good performance.
If you watch your portfolio and see how it fluctuates, your feelings will quickly falter. If the investments have performed well, the mood rises. Sometimes joy even turns into greed. If things go downhill, the mood falls. It starts as a quiet uneasiness and sometimes it escalates into fear.
In line with their mood, many investors buy a lot when their portfolio has done well – but do not invest when it has suffered losses (or worse: They sell then). That is human – but it is precisely the wrong thing to do for good performance.
We would like to show you today the impact on performance if you let your feelings guide the timing of your investments using two portfolios as examples.
Rational vs emotional
Let's invent two typical investors, Rita and Emil. For both of them we simulate a portfolio. Both start their investment in January 1999 with a deposit of 1,000 francs. Later they have the option of investing another 1,000 francs per month from their savings.
Rita invests her savings on the 1st of each new month. She acts rationally, her behaviour will turn out to be sensible and correct.
Emil, on the other hand, often leaves his savings in the account. He only invests when his portfolio is in the black. At the end of August 2001, his total return is negative and only turns positive again in July 2005. So Emil has a lot of catching up to do – he invests 47,000 francs at once.
Emil's attitude sounds good for our feeling: He stayed out of the market during the most unpleasant time and only resumed investing after the new upward trend had surely started. Emil trades emotionally, his performance will disappoint in the end.
Only Timing makes the Difference
For our example, let us assume that Rita and Emil both invest in the SMI. (With True Wealth, Rita and Emil would of course not only invest in the SMI, but in an individual portfolio that is globally diversified across all asset classes. But let us keep the math simple here).
The returns are identical for the money both of them have actually invested. We can therefore very well compare both portfolios. The only difference between Rita's and Emil's portfolios is the timing of new money available for investment – which was consistently later for Emil.
Emotional is Disappointing at the End
Nothing against Emil's portfolio: After all, he has built up savings and invested them sensibly over time. At the end of the 14 years of our simulation, his savings of 200,000 francs have turned into 287,456 francs. However, the comparison with Rita's portfolio is disappointing. She also invested 200,000 francs. But she invested them regularly. In the end, her portfolio is worth 307,773 francs – a whole 20,317 more than Emil's.
Expressed as a percentage, the difference is 7.1 per cent. Rita owes this additional return to the miracle of compound interest. She always invested as soon as savings were available, so her money could work for her longer. And although she made losses on her existing investments during the downward phases, she always bought in during these cheap phases. When the market recovered, it really paid off for Rita.
The fact that Emil did the right thing from his point of view, namely to hold further investments starting from the end of August 2001, actually helped him. Unfortunately, however, only in the very short term. Especially during 2002, his portfolio is ahead of Rita's. In the long run, however, Rita's regular investments clearly outperform Emil's emotional portfolio.
A Mistake Rarely Comes Alone
For our simulation we have assumed that there is only one difference: The timing of new investments. In real life, however, it could be unfortunately that investors with Emil's attitude would not only have made this one mistake. They might rather have made a few more mistakes typical for the emotional investor.
For example, it could be that Emil would not only have refrained from making new deposits in 2002, but that he would also have sold all his existing investments. At a time when they were really deep in the red – when the pain was great and the fear even greater. In this case, unfortunately, he would only have had few stocks in his portfolio to benefit from the subsequent recovery. That would have cost him far more in returns than just the 7.1 per cent difference to Rita's performance.
In its annual report "Quantitative Analysis of Investor Behaviour", the research centre DALBAR assesses every year how much return emotional investors give away. In the 2014 edition, it came to a difference of 4.2 per cent. This is how much worse the average private investor performed than the broad American stock index S&P 500. This value remained stable around four per cent for each year DALBAR has been conducting its survey.
It Pays off to Invest Regularly
Invest regularly, even if the portfolio is in the red. Don't sell because the portfolio is in the red. These are the two rules we can learn from our comparison. Always stick with your investments – even after losses. It pays to not take your feelings too seriously. It's better to look the other way.
That's not always easy when you look at the performance every day. But if you wanted to, you could definitely look the other way. Because with a wealth management company like True Wealth, professionals take care of the details of the investment process.
Nevertheless, you have to ensure a minimum of discipline yourself: Ensure that regular payments are made. The best way to do this is to set up an automatic standing order. This is not only very convenient, but it will also prove to be the right decision in the long run.