As investors, our greatest enemy is often our ego. Seven misguided beliefs about investing.
Procrastination is a widespread disease that usually starts with a harmless excuse: “Financial markets are very complex. I’ll deal with this tomorrow.” Then you postpone the matter for another day, and then another. But if you keep postponing your investment decisions, you’ll miss out on long-term opportunities to generate returns. Both historically and globally, equities have generated average annual returns of roughly 7 percent – notwithstanding the various crises. So what happens if you take a ten-year break from stock markets? At an average return of 7.2 per cent, you’ll have missed out on the chance to double your assets.
"I’ll just invest in the best stocks like Warren Buffett does, instead of spreading myself too thin”, is what many investors tell themselves. Warren Buffett has a big position in Apple shares. They make up 40 per cent of his portfolio – and have generated returns of over 800 per cent in the last ten years. And yes, success stories such as these are exciting. But they’re the exception. Just like not every good tennis player will be the next Roger Federer, not every company is going to make it to the top. That’s why the golden rule for investing is “Never put all your eggs in one basket.” But as American finance professors William Goetzmann and Alok Kumar found in a study, private investors often find that difficult. The typical portfolio of a private investor in the US contains only four stocks – and the situation is no better in Europe. Many investors have a concentration risk. And unlike Warren Buffett, they often can’t afford to carry that risk.
Why travel when there are so many great things so close to home? This is a motto that many investors adopt. And so instead of diversifying their investments internationally, they buy securities that were issued in their home market. Researchers call this phenomenon, which even institutional investors fall prey to, a “home bias”. But as any finance textbook will tell you, you miss out on a lot of opportunities if you don’t look beyond the tip of your nose. A study by the Frankfurt School of Finance commissioned by Nomura Asset Management found that home bias costs institutional investors in Germany 2.54 per cent every year. Interestingly, Switzerland is the odd country out in this context. First, because the franc is stronger than many other currencies, and second, because Swiss companies such as Nestlé, Novartis and Roche have a very strong international focus. As a result, patriotic Swiss portfolios have performed surprisingly well in recent years. That said, in the long run, it might be worthwhile for Swiss investors with a home bias to broaden their horizon. Why? Because investing in the popular Swiss stock market heavyweights leads to an unbalanced sector mix.
Many investors fall in love with glitz-and-glamour investments that makes a splash in the news. Take the payment processor Wirecard, for example. It was the stock market darling until it went bankrupt three years ago. Then you have cryptocurrencies and non-fungible tokens (NFT), which seem to almost magically attract attention and money. While some were calling cryptocurrencies the new “gold”, others were convinced that NFTs were the way of the future. NFTs for digital art and collectibles were especially coveted. Now that the hype is over, disillusionment has set in. So what went wrong? As we know from behavioural finance, investors become so attached to their favourite investments that they defend them passionately. Instead of selling a security that’s likely to crash, they convince themselves that everything will be alright. For example by telling themselves, "The bargain basement prices make it an even better investment. I can still generate attractive returns in the long term."
Just like almost everyone with a driving licence considers themself an above-average driver, most private investors are convinced they have a special talent for investing. So what are the consequences of this overconfidence? Among other things, that private households do too many stock market transactions without having any kind of strategy, as the American finance professor Terrance Odean found in a study. And fund investors are guilty of similar behaviour. The Morningstar rating agency found that between 2010 and 2018, investors who moved in and out of mutual funds missed out on valuable opportunities to generate returns compared to those who left their capital invested. And since fees are incurred with every transaction, the bottom line for investors is: “Shifting back and forth leaves you with empty pockets.”
If your portfolio is in the red, you’re likely to also see red in the figurative sense. Why? Because an investors’ emotional reaction to a loss is generally twice as strong as to a gain. So if an investor loses 10 000 francs, they will need to have a subsequent gain of at least 20 000 francs if they want to be happy. In extreme cases, this loss aversion can trigger paradoxical behaviour. Some investors try to recover their losses at any price. And they end up burning and even bigger hole in their wallets – like Jérôme Kerviel, for example. He was a trader at a major French bank who incurred losses and tried to make up for them by making increasingly risky investments. In the end, the bank lost almost 5 billion euro. Other people adopt a “Once bitten, twice shy” approach after losing money on an investment, and steer clear of investing from then onwards. But that’s not very sensible either. Because in the long run, negative and positive price fluctuations should balance each other out.
“The strong man is strongest when alone”, said William Tell in the eponymous play by Friedrich Schiller. That can be a dangerous credo on the stock market. People who act alone tend to be guided by their gut feeling rather than consistently following an investment strategy. A study by finance professors Thorsten Hens of the University of Zurich and Kremena Bachmann of the Zurich University of Applied Sciences found that the people who most urgently need financial advice usually don’t seek it or ignore it. The higher a person’s level of investment expertise, the more likely they are to seek professional advice – or delegate their portfolio management to professionals.
