After a bit of experience, most investors seem to get good at buying shares with reasonable timing. After making a purchase the shares tend to go up, or dividends roll in, or both, as planned and hoped for.
Poor performance
So why is it that several studies over the years conclude that individual private investors tend to underperform the market as measured by the returns of the FTSE 100, 250 and Small Cap indices and others?
The majority of fund managers, too, have taken a lambasting in recent times for failing to beat simple and inexpensive index tracking funds. However, even though they find it tough to beat the index, fund managers do tend to beat the average private investor according to research, which is a bit of a shocker.
Of course, it’s easy to get a false impression about all this. On bulletin boards, blogs and news reports we are not bombarded with investors telling us how poorly they performed at the end of each year, or how they just scored their seventh inverted ten-bagger (a share that ends up being worth one tenth what they paid for it). Instead, we hear the loudest broadcasts from those ‘survivors’ who did happen to do well on the stock market. They do exist, but I’d argue that their numbers are small compared to the great mass of investors who either underperform or lose money over time through stock market investing – the silent majority.
Your worst enemy
The problem doesn’t seem to be poor stock picking in many cases, it’s more likely to be what an investor does after purchasing a share that causes portfolio damage. The grandfather of value investing, Benjamin Graham, once said, “The investor’s chief problem – and even his worst enemy – is likely to be himself.”
So, what can we do to stop ourselves from repeatedly snatching failure from the jaws of success on the stock market?
Much underperformance seems to hinge around what investors do when it comes to selling shares. Generally, private investors appear to be good at buying, but then tend to sell:
- too soon, taking small profits instead of letting a winner run to reap big profits;
- too late, allowing a losing share to accumulate large losses instead of cutting early;
- too late, after a winning position has reversed and taken back previous profits.
I reckon a great way to improve investing returns is to focus much more on selling and to modify your mindset so that you cultivate the attitude that you buy shares to sell them at some point. That’s different from what many appear to do, which is to buy shares to hold indefinitely, or with no plan or rules in mind about when to sell.
A useful tactic
One useful tactic is to enter trades and investments because of compelling fundamental reasons and attractive valuations, but to allow simple technical analysis to inform you when to sell an investment.
Share prices tend to lead lagging news flow, so if your shares start behaving oddly, or an established trend falters, or a new purchase slides relentlessly down rather than rising as you expected, it could pay to act by selling. If you wait for the change in fundamentals or poor news flow to justify weak share prices, it’s often too late to save the damage to your portfolio.