Is Your Investment Portfolio like a Bar of Soap?

“New research indicates that your investment portfolio can be like a bar of soap - the more you handle it, the less you will have.”

The tendency of self-directed investors to underperform the market as a whole is well documented. Retail investors who do not use an investment adviser tend to lag the market as a whole by up to four percent per annum.

Compounded over longer periods, this level of underperformance has a serious impact on the ability to grow and maintain long-term wealth.

In New Zealand, many investors have recently signed up to new investment platforms such as Sharesies and Hatch.

These online services provide easy access to shares, bonds, and managed funds and enable investors to enter and exit positions at relatively low cost.

Unfortunately, trading volume statistics show that in some cases, this easy access tends to encourage active trading and attempts at market timing among retail investors.

So it’s timely to look at the experience of self-directed individual investors and their ability to withstand the temptation to buy and sell regularly.

A new study demonstrates that active trading significantly increases the volatility of a portfolio. In other words, market timers assume much more risk to get the lower returns they achieve, compared to investors who simply buy and hold.

In their recently released study, Ilia Dichev of Emory University and Xin Zheng of the University of British Columbia look at the connection between active trading and risk.

The authors find that although active investors tend to “chase stability”— i.e. they try to minimise volatility by market timing—they end up doing the opposite, according to the research, as they invest in stocks after past volatility is low and before future volatility is high.

The end result is high capital exposure when volatility is increasing. The professors find that “the volatility of the actual investor experience is nearly 50% higher than the corresponding volatility of stock returns.”

Volatility also grows over time. For example, a typical investor with a 30-year investment horizon experiences a 71% increase in volatility, at least compared to investors who just buy and hold investments.

Dichev and Zheng also show that the link between market timing and increased risk appears to be a global phenomenon. Their results hold across international markets, including Canada, Germany, Japan and the U.K.

Their study suggests that making trading easier is likely to backfire for most investors. Instead of celebrating the activity, we should be urging investors to stay focused on the long term.

We’re experiencing a period of high volatility, both for the world as a whole and for financial markets.

One proven way to make your investments less volatile in the new year is to do as little as possible with them. Avoid the temptation to pick up that bar of soap.

Disclamer

Bradley Nuttall Otago Limited believes the information in this article is correct, and it has reasonable grounds for any opinion or recommendation found within this article on the date of publication. However, no liability is accepted for any loss or damage incurred by any person as a result of any error in any information, opinion or recommendation in this article.

Nothing in this article is, or should be taken as, an offer, invitation or recommendation to buy, sell or retain any investment in or make any deposit with any person.

The information contained in this article is general in nature. It may not be relevant to individual circumstances. Before making any investment, insurance or other financial decisions, you should consult a professional financial adviser.

This article is for the use of persons in New Zealand only.

The views and opinions expressed in this article are those of the author and are not necessarily those of Bradley Nuttall Otago Limited