30 May Hobby investors
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Some years ago, when my wife worked for a trade body in the UK investment sector, I drove her to an evening meeting of an investment club which was considering employing some collective investment funds in its portfolio. I can’t remember exactly why I went along (possibly because I knew the area and she didn’t) but having arrived, I was invited to come in rather than sit in the car outside. The offer of free tea and buns made that an easy decision, so I accepted.
As I was something of an interloper, I sat quietly as the discussion went on and the members of the club outlined their reasons for forming the group and the approach they followed. From what I have read, I suspect that there is much in common with other such clubs, in that they wanted partly the social interaction and the mental stimulation but also to learn something about investing and to make some money. They were a personable crowd and they also seemed to have fun doing it. I understood from what they said that none of them depended on the club to meet any of their financial objectives and the modest level of monetary contribution that each was making was not going to result in any of them becoming destitute if it all went horribly wrong.
This is probably just as well, as confusing the means and the ends with investing is a dangerous mistake to make. We are bombarded daily with stories of how people made or lost millions (or in the case of whole markets, billions) and from that it is hard to avoid the conclusion that investing is exciting. We all like to tell our friends about our successes in beating the market and picking winning stocks and then getting out before they blew up. Yet despite all the decades of academic literature and research about understanding risks, constructing portfolios efficiently, diversifying and staying disciplined, treating investing as an objective of itself rather than a way to achieve an objective is alive and well in some quarters.
For some people, investing is a hobby. They digest the media’s output and follow one or more of those they perceive to be gurus and while the evidence may overwhelmingly indicate that almost everyone is no better at picking the right investments and timing when to buy and sell them than a dart-chucking monkey, they persist in the belief that they are in the tiny minority which is. We should probably not be surprised at this, as there is evidence from psychology that people generally believe themselves to be above average at most fields in which they participate. This is notably the case with driving, yet it is clearly impossible, as in Lake Wobegon , that everyone can be above average. Since investing is another field where a wide range of capabilities will be apparent, even if not all are visible to an observer, the proportion of participants which is above average will be no more than half the total.
What is interesting is that when scientific studies are carried out into the capabilities of populations to make investment decisions, the results are often counter-intuitive. For example, a 2010 study of corporate executives (people who might be expected to have some greater insights into the likely futures for their businesses) who made 11,600 forecasts for the S&P 500 Index over nine years found that the executives’ forecasts were negatively correlated with the actual outcome. Their predictions were actually worse than random chance would have predicted.
Those who have read Hans Rösling’s excellent book Factfulness will recall that his years of asking politicians, journalists and business people a series of questions about economic development to choose between three options resulted in almost all groups regularly scoring lower than the apocryphal dart-chucking monkeys would have done. It seems that some knowledge of the subject is not always helpful, particularly if the knowledge you have is actually not supported by reality.
Apparently there is a gender bias to this too – two US researchers found that males are for more prone to overestimating their abilities when it comes to investment forecasting than females. Their findings have been repeated in other studies. They also trade more, thus incurring more costs and taxes.
If you are one of these people, the chances are that you are just not going to be inspired by a strategy which advocates accepting the market return, diversifying so that no holding is large enough to make a killing (or be killed), trading efficiently and controlling costs. It’s just not exciting.
Realistically, if your mindset is that you are one of the minority whose abilities allow them to predict the future with greater accuracy than the other market participants and to convert that into superior investment returns (the two are not necessarily correlated), then there is probably little chance that you will have a Saul-like conversion and suddenly switch to accumulating your wealth by patient and efficient investing. Apart from anything, it would require admitting that you are not as smart as you thought and none of us likes to do that.
What may be more palatable is to separate the pot which you are using to provide your family’s future financial security from that which you use to pursue your investing hobby. It allows you to speculate on market movements in the knowledge that if you do mess up (or rather ‘the market moved against me’) with a relatively small proportion of your wealth while the bulk of it is doing the boring job of growing slowly and relying on the drivers which research has repeatedly shown to deliver the long term returns.
This is effectively what the investment club was doing. It is also what a few of our clients do, in that we have set up execution only accounts in which they can buy and sell whatever securities they want as frequently as they want but in the knowledge that any returns that they achieve are a bonus. More importantly, their financial plan allowed them to determine the extent to which they could afford to allocate capital to this account such that if it all went to zero, their family’s financial security would not be compromised.
There is nothing wrong per se with treating investing as a hobby – like the weekend angler though, it’s a matter of knowing that the one which got away is not going to mean that your family will be eating roots and berries for dinner tonight.