Every generation thinks that they live through unprecedented times. There certainly seem to be enough extraordinary issues to worry about currently, from political gyrations to the longstanding economic worries dating from the start of the global financial crisis 10 years ago. It’s true for many investors too: the belief that ‘this time it’s different’, as recent experience dominates attention and the lessons of earlier history fade from our collective memory. Financial markets have been unusually subdued in recent months, but this benign market environment too will pass at some point. And despite all the popular concerns, the catalyst for disruption of this collective mood will probably be something about which the financial world is not currently troubling itself.
The role of discretionary wealth managers is to navigate client assets through these uncertainties; the known risks as well as the unknown ones. And the reality is that investors are notoriously bad at predicting when, not just if, different risks will surface. That’s why managers look for diversification when building client portfolios - to protect against these uncertainties. Regardless of a given client’s investment horizon or objective, there should be holdings in portfolios that perform better in different environments, because every investment will probably go through a period of time when it underperforms.
The latest version of a leading study by Dalbar Associates has found that over the last 30 years, the average investor experience in US stocks has been a return of less than half the broader market return per annum (3.98% for the investor vs 10.16% for the market) in part because they have repeatedly chosen the wrong points to trade in and out of the market. Switching between misplaced confidence and loss-induced pessimism as newsflow changes has a massive impact thanks to the power of compounding returns over a sustained period of time. The ‘missing’ annual client returns have been eye-watering! It’s a pattern that repeats across asset classes and around the world, and it means that such investors have to invest more of their money, for longer, to reach the same outcome.
Source: Dalbar Associates. Returns from 1st January 1987 to 31st December 2016, in US dollars
We believe that taking a longer-term attitude and applying a strategic approach to portfolio construction is the best way to protect against the damaging impact of such behaviour. Strategic allocations should always be the main driver of client portfolio returns. Avoiding any knee-jerk reactions to events which may do more damage than good will enable clients to have the best chance of meeting their investment goals.
Please remember that when investing your capital is at risk.