How to Outperform the Average Investors?
Following a Plan is Easy Until You Try Following
In the previous series of selecting a value stock, we went through a plan to select value stocks for our portfolio. And now, your only job is to follow the plan. However, this is easier said than done. It is one thing to agree with a plan, it is another thing to carry it out.
In the military, there is a famous saying, “No battle plan ever survived first contact with the enemy.”
While there are no bullets darting across the stock market, it certainly does punch you in the face when you fail to follow a plan. Whether it is during a mortgage subprime crisis or a negative interest rate environment, any investing strategy can only be successful if the investor endures the tough times. However, studies have revealed that we are not wired to be a good investor and most of us could not endure the tough times.
According to an article by Forbes, an average investors only achieve about 2% gain on their portfolio annually. This means that despite our best effort, we still lost out to a simple buy-and-hold strategy using S&P500, which on average achieves about 6-8% gain annually. While there are other contributing factors, many studies have come to a similar conclusion that the poor returns are often caused by human behaviours.
Your Body is Not a Wonderland
Looks like we only grew taller. Source: wp.stockton.edu
In the last 100 years, our society or rather our world, has changed dramatically. We have gone from riding horses on the plains to launching rcokets into space. We advanced from countries with isolated economies to almost complete globalisation of trade. In contrast, the human as a physiological being has not changed much. If you take a look at a human fossil 3000 years ago, it looks eerily similar to a modern human skeleton. However, the environment which our ancestors lived in is vastly different from ours. Therefore, our physiology is literally a living fossil that evolves painstakingly slow in comparison to our modern world.
In the early years of human history, we have to avoid being hunted by predators such as lions and bears in order to survive. Therefore, our bodies have gradually evolved to possess certain survival instincts that are subconscious to us, this means even when we are aware of it, we still can’t help ourselves. Think about the last time you bought something on impulse and come to regret it subsequently, that is a manifestation of our survival instinct to cache food or any beneficial items when it presents itself.
In particular, we developed very strong instincts against any sense of danger. When faced with danger, most creatures, including humans, will display one of two responses. Either find safety in numbers or a “fight or flight” response. You continue to see this in nature today. Fishes cluster in shoals to avoid being eaten by a predator, and when singled out, a fish will try to escape. While our physiology is programmed to increase our chances of survival in the wild. But those exact instincts are killing investors in the stock market.
Don’t join the lemmings. Source:http://www.greekshares.com/lemming1.php
To Herd is To Hurt
Our instinct to follow a herd and find safety in numbers decimates an average investor’s return. We develop this false sense of safety when we see our actions are inlined with everyone else despite understanding the basic concept of buying low and selling high. Time and time again, people have invested in the stock market when everyone is cheering the uptrend and the market prices are at all time high, and sold their investment when the market sentiments is poor and others are exiting the market too. This “herd” instinct caused many investors to commit the cardinal sin of “buying high and selling low”.
Worst Flight Ever
Even if you managed to fend off the “herd” instinct, your natural response towards a “dangerous” market that is trending downwards is probably to sell off your investments and stay out of it. This is a typical “fight or flight” response. In this case, your mind believes that it can’t defeat the market hence subconsciously it pushes you to the “flight” response and quickly remove yourself from the seemingly dangerous position (Very much like the fish escaping from the predator). However, this will have an adverse impact on your portfolio as you will be selling at low prices.
Save Me From Myself
Back to the topic of this post, “How to outperform the average investors?”. In short you need to save your portfolio from yourself. You just need a disciplined structure towards your investing plan. This is why formulating strict investing rules are so important. For example, in the past posts we highlighted specific rules towards analysing companies and their valuation. One of the valuation rules was P/OCF ratio of less than 10. With this rule, you are effectively removing yourself from the valuation process. While your survival instincts tell you not to buy a stock during economic crisis, the P/OCF ratio will help you make an objective decision.
I hope this post will help to reduce your impulse actions in investing. Remember, the market is irrational in the short term so just focus on the long term. Don’t fly into the flames like a moth!
FOCUS = Follow One Course Until Success!
See you soon!
Investing Always,
Pete
