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The biggest risk to your investment portfolio

Many investors do not realise that often they are the biggest risk to their investment portfolios.

In the 21st century data is so freely accessible that the layperson is capable of just about anything. The term DIY (do-it-yourself) has moved from the garage and into every part of our lives, the garden, our hobbies, and most importantly the investment arena. In the last 10 years the number of DIY financial advisory books has surged. So why not just do-it-yourself?

A Boston research firm, Dalbar, recently released its 20th annual review Quantitative Analysis of Investor Behavior. The study observed actual individual investor returns over a 30-year period from 1984 to 2013.

The findings show that individual investors are remarkably poor decision-makers, especially for themselves.

During this period there were multiple bull and bear markets, which you’d think gave investors an opportunity to learn from their previous mistakes, but it’s clear from the table below that they didn’t.    

In an unrelated study, Fidelity Investments conducted research on its Magellan Fund from 1977-1990, during Peter Lynch’s tenure. The average annual return during this period was 29%. This is well ahead of the S&P 500, which is, without question, the most widely followed stock index in the US. It should be noted that this was no secret to the investment community.

Fidelity’s Magellan fund became one of the largest mutual funds due to its success under Lynch, so it is clear that investors were aware of its performance.

Whether the investors in the fund were chasing performance, or investing due to his expertise is unclear. What is clear is that investors learned that Lynch was investing in a way that worked.

Given all this, you would expect that the investors in his fund made substantial returns over that period.

However, what Fidelity Investments found in its study was shocking. The average investor in the fund actually lost money. Yes, that’s correct, lost money when the fund returned 29% each year for 13 years!

Human psychology has been identified as one of the most common reasons for the underperformance in both these studies. Investors chase the returns of the best-performing mutual funds, which get them nowhere.

As we know, the performance of investment themes come and go but as an investor, you need to be patient, ensure you are well diversified, and that the expected risk versus return is in your favour.

Don’t believe me? Look at some of these outflow figures in the South African general equity category over the last year.

Many large asset managers were a bit early on the turnaround in resources and as a result underperformed their peers massively in 2015.

Even though these funds have had a turnaround of late, the large outflows in these portfolios suggest how fickle investors are.

While we don’t necessarily agree that resources have reached the bottom, it’s startling to see that some of the most respected asset managers in the industry, with massive marketing budgets and good long-term track records, have struggled to retain clients amidst poor performance.

Risk comes first in our business; in fact, we often tell our clients that it’s our job to ensure that they sleep well at night. Many DIY investors are arduously navigating financial markets on their own, with little time to decipher the importance of what they are reading or hearing.

Being able to lean on a wealth manager removes at least some of the behavioural biases involved in investing, giving you time to focus on what matters in life.

Investing is not without risk, but the journey to your investment goal will be that much smoother by eliminating one of the least obvious risks  you! 

Nick Pawley is a CFA and wealth analyst at AlphaWealth.

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