Your worst enemy

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  By Guest Blogger Sinan Terzioglu

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Peter Lynch was a famous fund manager that ran Fidelity’s Magellan Fund from 1977 to 1990 and generated an average annual return of 29%. It would seem there were a lot of happy clients during those years, but according to Fidelity the average Magellan Fund investor lost money during the period Lynch managed it. How was that possible?

This is an extreme example because I don’t think Lynch would have been able to come close to achieving a similar result over most other time periods, but it highlights the behavioral challenges investors deal with on a regular basis. They are often their worst own enemy by not being patient and sticking to a proven investment plan.

According to a 2021 study by DALBAR, from 2000-2020 the average equity fund investor underperformed the S&P 500 index by approximately 1.50% per year. This is consistent with other studies over various time periods and clearly shows investors all too often get in their own way and do much more harm than good by letting emotions drive investment decisions. I think a quote from Warren Buffett’s mentor, Benjamin Graham, summarizes this well:

“The investor’s chief problem – and even his worst enemy – is likely to be himself.”

One of the most costly investment mistakes investors make is trying to time the market.

A study by Morningstar looked at the 5,217 trading days between 1997 and 2017, finding that investors who stayed fully invested in the US stock market would have generated a compound annual return of 7.20%. But an investor that missed the 10 best days would have generated just 3.50% per year. An investor that started the period with $100,000 and stayed fully invested would have had approximately $400,000 20 years later. But had the investor missed the 10 best days their investment would be a little over $200,000. Needless to say, attempting to time the market is a very costly mistake and can make a significant difference to one’s long term financial well-being.

As interest rates began to rise in March 2022 the markets sold off as various assets were repriced and many anticipated a looming recession in the year ahead. A lot of investors followed the herd and sold out of fear. By the end of 2022 the S&P 500 had dropped by approximately 20% from its all-time high. Fast forward to today and we haven’t entered a recession and the US market has recovered a fair bit and is just 7% from its apex. We will eventually enter another recession at some point but the last year and half shows that trying to anticipate the timing of one as well as stock market corrections is a losing strategy. Going back to Peter Lynch I think one of his famous quotes says it best:

“Far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves.”

Fidelity reportedly conducted an internal study of the performance of client accounts between 2003 and 2013 and found that the accounts that performed the best were of investors who were dead. The accounts that performed second best belonged to investors who forget they had them. This is not the only study that shows that slow and steady investing wins the race over the long term but it also highlights how detrimental so many active investment decisions are and how successful investing is more like watching paint dry. Investors that do not regularly check their portfolio and who ignore the daily, weekly and monthly fluctuations are far more likely to stick to a proven investment strategy and not get in their own way as so many investors do.

Over the last several decades a balanced and globally diversified portfolio has generated an average annual compound return of between 6-7%. To have achieved that result investors would have had to have remain patient and sit through some periods of underperformance and even market turmoil such as the Financial Crisis of 2008-2009. One of the challenges with diversification is that there will always be positions in a portfolio that are going to underperform but that should not concern you if you have a well thought-out plan based on your long term objectives and risk tolerance. The best investments have never appreciated in a linear way.

Since 1965 Warren Buffett’s Berkshire Hathaway has generated a compound annual return of approximately 20% but what’s not well known is Berkshire Hathaway underperformed the S&P 500 over 1/3rd of the time over the last 58 years. So long as you have a well thought-out and proven investment plan such as a balanced and globally diversified portfolio you will do yourself a lot of good by keeping this in mind when judging the performance of your portfolio over various time periods.

So long as you stay invested and focus on what you can control such as your savings rate and ignore what you cannot control such as market volatility and the financial media, you will significantly increase the probability of reaching your financial goals over the long term. Most importantly you will not be your own worst enemy.

Sinan Terzioglu, CFA, CIM, is a financial advisor with Turner Investments, Private Client Group, Raymond James Ltd.  He served as vice-president of RBC Capital markets in New York City and VP with Credit Suisse in Toronto.