Exuberance, Panic, Timing: Investing in Shares

A US-based firm Dalbar has put together an interesting report on investor behaviour. Every time I come across the report that Dalbar produce annually, I am impressed by the gap they find between the returns that the average managed fund investor gets and the simple average market return – the average market return is always stronger.

In Dalbar’s 2016 analysis, the average managed fund investor over the 20 years to the start of 2016 received a return of 4.67 per cent per annum, while average share market returns for the same period for the S&P 500 index (it is a US-based study) was 8.19 per cent per annum.

To put this in dollar terms, the average managed fund investor turned $10,000 into $24,600 over the 20-year period to the start of 2016. An investment that received the same return as the S&P 500, turned $10,000 into $48,300.

The discussion as to why the average managed fund investor did so poorly leads to the core discussion of this article – is investing in the share market more challenging that we give it credit for?

Voluntary Behaviour

The Dalbar study suggests that the key reason investors did so poorly over a 20-year period was ‘voluntary investor behaviour’ which, in this case, was: panic selling, exuberant buying and attempted market timing.

None of these investor behaviours are particularly surprising, but they do pose the question – is investing in shares more challenging that we acknowledge? This question has particular relevance here in Australia where more than 10 per cent of most employees’ income (through superannuation) is now directed toward a portfolio that is likely to hold significant assets in Australian and global shares.

There are three elements that deserve consideration when thinking about the challenge of investing in shares:

• The challenging of selecting companies to invest in
• The challenge of market timing
• The challenge of volatility

Buying Companies

At the very core of investing in shares is the idea that you are becoming a part owner of companies, or a portfolio of companies.

Accumulating assets through a balanced superannuation fund, or a managed fund, ETF or index fund investor means the decisions around which companies to buy have been outsourced to a fund manager or the index weighting.

However, those investors who choose their own shareholdings are not always faced with an easy decision.

UC Berkeley's Terry Odean studied 10,000 brokerage accounts of individual investors. Part of the study looked at situations where one share investment was sold and another purchased at about the same time. Clearly, in making the trade, the investor hoped to be buying a share that had better future returns. This did not happen, and the shares that they had sold tended to perform better than the shares purchased by a considerable margin. (This research is discussed in more detail here.)

For those choosing their own shares, the first level challenge are those buying and selling decisions of the underlying companies in the portfolio. With each decision to trade comes brokerage and possible tax costs. The decision around which companies to own, and how frequently to trade, is not without challenge.

Market Timing

The Dalbar study mentioned earlier found that the biggest underperformance factor for investors, equal to 1.5 per cent per annum, was ‘voluntary investor behaviour’, which was largely linked to the market timing behaviours of:

• Panic selling
• Exuberant buying and,
• Attempted market timing.

In some ways, we stand at a fascinating point in time to reflect on market timing decisions, with two significant market downturns in the last 15 years — the Global Financial Crisis (GFC) and the COVID-19 downturn.

We can clearly identify the panic selling times – at the bottom of the GFC downturn when Australian shares had almost halved in value, and at the bottom of the 2020 COVID-19 downturn. We can also see that investors who held shares at those times subsequently received reasonable returns, and any investor with the courage to buy (or just rebalance portfolios towards equities or keep making regular contributions into shares) received above average investment returns from there.

Perhaps the only time of ‘exuberant buying’ in this period was as the market made new highs in 2007, prior to the GFC, where RBA data showed margin lending to buy shares was at its highest point. Of course, that turned out to be a particularly poor period of time to be buying extra shares, with the October 2007 high of 6828 points being within reach of where the market is more than 15 years later.

The challenge of resisting the pressure to sell, and even making good buying decisions when markets have fallen and negative headlines are everywhere, is a significant one.

Market Volatility

The third challenge is linked to the second: how do we manage the inevitable volatility that comes with investing in share markets?

The ASX has just released a report into Australian investors, and their reporting of attitudes to volatility is interesting.

An increasing number of investors, now 67 per cent in 2023, prefer guaranteed or stable returns, while only 33 per cent preferred higher variability (volatility) for higher returns.

There seems to be some tension in the report, which saw increasing number of investors up from nine million in 2020 to 10.2 million in 2023 investing, but an increasing reluctance to lean into market volatility.

In terms of calendar year returns, over the past 25 years the average return from Australian shares has been 8.5 per cent per annum. That is not a bad return by itself, albeit a little below the longer-term average from the Australian share market and would have seen $10,000 invested 25 years ago turn into about $77,000 today.

Let’s make that 8.5 per cent per year into a /-3 per cent range and consider 5.5 per cent to 11.5 per cent as being an average return for a year. Amazingly, only two years from the past 25 had returns within this range: 1998 with a return of 8.5 per cent; and 2001 with a return of 10.1 per cent.

That means that it has now been more than 20 years since we have had an annual return from the Australian share market in a ‘normal’ range of /- 3 per cent of the average share market return. (To avoid being accused of selective analysis that supports a narrative, the 2016 calendar year return of 11.6 per cent only just missed out on this 3 per cent /- range).

Conclusion

Australians are, increasingly, share market investors, nudged in that directly by compulsory superannuation which, even in a pre-mixed style balanced investment fund is likely to have reasonable levels of share-based investments.

Perhaps what has not been acknowledged at a collective level is the difficulty of being a share investor. Which companies to buy? What to do when share markets are down by 40 per cent, superannuation balances are down by 25 per cent and the headlines are scary? And how to cope with the ongoing ups and downs of the market?

At an individual level, building a thoughtful philosophy around company selection, market timing and reacting to volatility should support portfolio performance over time.