Why the average investor is so bad at it.

Published By StennerZohny Investment Partners+ on July 4th, 2016

 

 

The annual Quantitative Analysis of Investor Behaviour study from financial services consulting firm Dalbar Inc. is a tough read. Not because it’s data-heavy and dry (though it is), but because of its implications.

Every year, the survey looks at U.S. mutual fund inflows and outflows, using these data to calculate the real-life performance experienced by the “average” fund investor over time. It then compares this performance to that of a representative benchmark for a given asset class.

As you can see from the chart, the performance of the average U.S. equity fund investor isn’t anywhere close to the benchmark. That’s not just bad – it’s shockingly bad.

Now, there are good reasons why an individual’s performance might lag the index: Maybe there’s a financial goal an investor has to pay for regardless of market conditions. And of course, fees and transaction costs create a headwind for funds, but not for an index.

Still, these don’t account for the massive performance miss. What does? Behavioural biases. Selling low, buying high; switching to and from funds at the wrong time; chasing “hot sector” performance; unloading core positions to invest in the “fund du jour” – these are actions we take because of hidden prejudices that affect the way we process market information.

Over the past 30 years, I’ve noticed the wealthy tend to be less susceptible to such biases. They tend to be better at recognizing potential biases, as well as controlling the emotions that ultimately lead to them. Here are four examples:

Recency bias

This is the bias that leads us to place a great deal of importance on recent events, and discount or ignore those in the past. We can see this at work when investors pile into and out of positions based on short-term news and current events, without much thought for long-term implications. Case in point: What’s happening right now with the current volatility brought on by the U.K.’s Brexit vote.

Most of the high-net-worth (HNW) investors I’ve met have a keen understanding of market history. Absolutely, they pay attention to what’s going on right now. But rarely do they make that the foundation of their investment decisions.

Confirmation bias

This is the tendency to seek out information that supports our pre-existing opinions, while discounting information that may refute them. Turning again to Brexit, this explains why many investors were caught offguard by the surprise “leave” vote.

Most of the HNW investors I know actively seek out contrary opinions. They do “what if” analyses: what if they’ve gotten it wrong, assumed too much, or overlooked something? Some of them even select members of their advisory team to advocate contrary opinions, to ensure no risk has been overlooked.

Optimism bias

Closely related to the above, this is the tendency to resist information that casts our pre-set beliefs in a negative light. We see this with the reluctance to sell losing positions. Many investors believe that “it will come back,” despite obvious evidence that an investment thesis has changed.

By contrast, HNW investors generally have good selling discipline. No, they don’t like losing money on an idea that didn’t work out. But they don’t let pride or shame get in the way when it comes time to cut their losses.

Social proof

It’s human nature to seek out others who affirm our actions and opinions. And when we see others do something, there’s a natural “pull” to do the same thing. This bias helps explain the “FANGs” (Facebook, Amazon, Netflix and Google – the latter now a subsidiary of Alphabet Inc.) and other hot stocks: The more attention strong stocks get, the more attention they attract from investors who don’t want to miss out.

Most HNW investors I’ve met are natural contrarians. When they learn what the investment crowd is doing, they often want to do the exact opposite. When they identify hot stocks, they want to avoid them – or short them. When they see assets that have been beaten up, they think opportunity. This goes a long way to explaining their consistently superior returns over time.

 

 

Thane Stenner is portfolio manager and director of wealth management of StennerZohny Investment Partners+ within Richardson GMP. He is a founding member and chairman emeritus of TIGER 21 Canada and author ofTrue Wealth. The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinion and estimates constitute the author’s judgement as of the date of this material and are subject to change without notice. We do no warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstance and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them, having regard for their own particular circumstances. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trademark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. both used under license by Richardson GMP Limited.

Having the family ‘wealth talk’: Four tips to remember

Published By StennerZohny Investment Partners+ on June 22, 2016

 

Let me ask you: How much have you spoken to your kids about wealth? I’m not talking about teaching them savings habits or giving them the occasional investment tip. I’m thinking about a family wealth discussion: how wealthy the family is, how much the kids will inherit, and on what terms.

If you answered, “We haven’t,” you’re not alone. In fact, a recent survey from U.S.-based SEI Private Wealth Management reveals a shocking knowledge gap about family wealth, even among some of the wealthiest families in the world.

Its findings: More than 80 per cent of United States, ultrahigh-net-worth parents (average net worth: more than $18-million) haven’t let their children know how much inheritance they will receive. And only 20 per cent of them had given their kids any training, education or coaching on family wealth matters.

Over the course of my career, I’ve heard plenty of reasons for not having the family wealth talk. Many parents want to have the conversation at some indeterminate time – when the kids “grow up,” for example. Others feel anxious that letting children have a full picture of how wealthy they are will damage the kids’ work ethic. And then there are a few who believe that the subject isn’t really any of their kids’ business.

This can be a significant predictor of future financial disputes within the family. I’ve seen more than a few family wealth “horror stories,” and while no two of them are exactly alike, the common thread is almost always incomplete or ineffective wealth communication.

The fact is, learning how to live with wealth is like learning a new skill: It doesn’t come as soon as you reach a certain age, or when you land your first job, or get married, or buy your first home. It comes through hard work and practice over time. Here’s how parents can make sure their kids acquire that skill.

Find ‘money moments’

Many high-net-worth families I meet don’t have a problem talking to their kids about wealth, but they’re unsure about how or when they should start the conversation. Alternatively, they can feel that such discussions needs to be structured, or planned, in a formal way.

There’s nothing wrong with a structured discussion. But that’s not the way wealth works in our lives. Most of the time, our knowledge of how wealth works (and how it affects our lives) happens in spontaneous moments, as we navigate through life events that touch upon money and personal finance in some way. Learn to make the most of these money moments. For example, a child’s wedding might be a good time to talk about transitioning wealth to the next generation; the birth of a grandchild is an excellent time to discuss wills and estate planning.

Over time, these smaller, in-the-moment, conversations will serve to highlight family wealth values, and open up further conversation.

Dialogue, not monologue

I’ve met many people who treat family wealth discussions as a monologue: The older generation tells other family members what they’re doing, without giving the younger generation an opportunity to voice opinions, express concerns or effect change.

At best, this is a missed opportunity. At worst, it sends a powerfully negative message to your heirs, showing them that their input isn’t valued, and reinforcing old family hierarchies that can so often be the source of friction.

Rather than declaring what your wishes are and assuming everyone will go along with it, try engaging your heirs in a dialogue. Encourage them to ask questions. Listen to their concerns. Get their perspectives. You don’t have to agree on everything, but simply by changing the structure of the conversation, you can go a long way to smoothing out potential conflicts before they happen.

Be open to new ideas

When it comes to transferring wealth from one generation to the other, parents may have a firm view of what they want to accomplish. But that shouldn’t invalidate new ideas from the younger generation. Taking a “my way or the highway” approach when it comes to passing on family assets is almost certainly a recipe for resentment and hostility.

Always remember: The key word in family wealth is “family.” That means being open to improvements and considerations given to other members of the family, and understanding that their ideas may be different from your own.

Play the long game

A lot of families treat wealth communication as a “one-shot deal.” In their minds, talking about wealth is something that happens infrequently – once every several years at most, in which family members come together for a roundtable discussion on a variety of topics, and then largely put the issues aside and get on with life.

Don’t get me wrong: Some conversation is better than no conversation. Still, communicating about family wealth is something that should happen over time. Ideally, the conversation should be organic – something that grows, develops and changes over the years to adapt to changing financial and family circumstances. Like much of wealth management, communication isn’t a sprint, it’s a marathon that requires a disciplined, steady pace to succeed.

 

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinion and estimates constitute the author’s judgement as of the date of this material and are subject to change without notice. We do no warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstance and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them, having regard for their own particular circumstances. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trademark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. both used under license by Richardson GMP Limited.

What wealthy investors are doing with their money right now

Looking to become wealthy one day? Pay close attention to what high-net-worth (HNW) investors do with their money. By following the moves of people who have demonstrated the ability to create wealth, you stand a much better chance of creating some for yourself.

 

One useful tool for tracking how the wealthy are investing (and what they’re thinking about the market and the economy) is the quarterly member survey from TIGER 21, a North American peer-to-peer network for investors with a minimum net worth of $10-million.

 

The group conducts these surveys by giving members a detailed, confidential questionnaire asking how much of their portfolios are allocated to which investments, and how those allocations have changed over the past quarter.

 

Currently, the network has almost 400 members in Canada and the United States. All of them are highly successful investors, with substantial experience identifying both public and private investment opportunities. Collectively, they’ve thought a lot about wealth – how to create it, but also how to protect it.

 

There’s been a significant increase in volatility throughout global equity markets; that volatility has resulted in subtle but meaningful changes in the portfolio allocation of the typical TIGER 21 member.

 

Continued move into uncorrelated assets

 

HNW investors know there is no way to eliminate market volatility, but the changes in their asset allocations show how they’ve tried hard to minimize its effect on their portfolios.

 

While the changes in allocations to equities (down 4 per cent from the previous quarter), fixed income (down 10 per cent), and real estate (down 3.5 per cent) may seem small, collectively they indicate how HNW individuals are adapting a defensive posture, seeking assets with performance uncorrelated to the broader market.

 

Unsurprisingly, private equity was the main beneficiary of these moves, with the typical allocation rising from 20 per cent to 22 per cent of the portfolio. Over the past six months, allocation to private equity has climbed by more than 20 per cent.

 

This is a clear indication that HNW investors continue to see private equity as an excellent place to both build and protect wealth.

 

Caution flag is up for public equity

 

The same cannot be said for public equities. The typical TIGER 21 member now has about 23 per cent of the portfolio allocated to publicly traded equities, a drop of about 4 per cent from the previous quarter. The allocation remains very low on the historical range (prior to the great recession of 2008, for example, allocation to public equities topped 31 per cent), and indicative of the general caution the wealthy feel about publicly traded stocks.

 

It’s interesting how low this allocation is compared to the traditional 60/40 equity/fixed-income model portfolio. Such an allocation is typically considered the starting point for most “balanced” portfolios, but it seems HNW individuals don’t buy into that mindset. Their allocation to equities is low even compared with the usual “defensive” posture of 40/60 equity/fixed-income that many investors default to in times of volatility.

 

Little love for fixed income

 

The third quarter of 2015 saw a fairly significant jump into fixed income; that jump was reversed in the fourth quarter, as allocations to fixed income dropped back to 10 per cent of the overall portfolio. This seems to be the opposite of what most investors do in times of volatility – at 10 per cent of the overall portfolio, the allocation to fixed income remains far, far below what would be considered a typical defensive portfolio.

 

The reason for a low fixed income allotment? Most HNW individuals continue to see traditional bonds as an unattractive risk/reward scenario. Historically low short-term yields, and widening credit spreads on the riskier side of the bond market, signal danger.

 

This is another explanation for the shift into private equity, as well as the sizable move to real estate, an allocation that has dropped over the past several quarters but remains substantial. Both assets offer tax-advantaged yield that’s often far superior to what’s currently offered by bonds.

 

Cash build-up continues

 

Several HNW individuals have expressed to me their intention to build up cash in anticipation of purchasing deeply discounted, distressed assets at some time during 2016. You can see this move at work this quarter, as the cash allocation increased from 9 per cent to 10 per cent of the overall portfolio. This is the same move that worked for many TIGER 21 members coming out of the great recession of 2008.

 

Concern over Canadian real estate, bank stocks

 

I learned some additional insight earlier this month at the TIGER 21 annual conference in Beverly Hills, Calif. HNW individuals were still raising cash into 2016 but were also now hunting for top opportunities in commodities – including energy – and in master limited partnerships. Due to concerns about valuations and credit markets, sentiment is starting to turn more cautious on both real estate and private equity.

 

Meanwhile, members are definitely getting more concerned about the risk of a pullback in Canadian real estate values, as well as bank stocks in Canada. More broadly, the feeling is that global credit markets are clearly pointing to some bigger problems ahead and global equity markets still have some more downside risk, even if there is a minor brief rally.

 

Over all, wealthy investors remain firmly focused on defence.

 

 

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinions and estimates constitute the author's judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them, having regard to their own particular circumstances. Insurance services are offered through Richardson GMP Insurance Services Limited in BC, AB, SK, MB, NWT, ON, QC, NB, NS, PEI and NL. Additional administrative support and policy management are provided by PPI Partners. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.