How Do Emotions Affect Investment Results?

Aug. 19, 2010 - PRLog -- Human emotions affect many investment decisions, all too often. AMG/Lipper had disclosed one of the largest weekly net outflows, in late July, from the equity mutual funds and equity ETF’s on record. $11.6 billion was withdrawn, implying a huge rally. The size of rallies after net withdrawals of $4.0 billion or more tends to be commensurate with the size of the net outflows. Then in the first week of August AMG/Lipper showed inflows of $8 billion.

   In the July edition of my monthly subscription to The Journal of the National Association of Personal Financial Advisors, I read some very interesting facts about the detrimental impact that emotions have on investing. The title of the article is “Investing With the Big Picture in Mind” by Kevin Adler and here is what he wrote, “The best fund in the last decade returned 18 percent per year compounded. But the actual returns of the average investor in that fund was minus 13.7% per year, according to The Wall Street Journal.” The article goes on to state that investors would pour money in after good periods and take money out after bad periods, the exact opposite of what wisdom says to do.

   I have clients, named Larry and Sonya, in Tennessee and they were wise enough to make their 2010 Sep IRA contribution at the end of July! Wow, pretty impressive and emotionless. Their money has already grown and I bet this will end up being a good move on their part. However, Larry and Sonya are the exceptions, not the rule. As a CERTIFIED FINANCIAL PLANNER™ Practitioner I would never recommend one of you to just take money out of your account because you are upset with the past few months or so. So with all of these emotional moves that clients make who is winning?

   Well certainly not me, the financial advisor. I am fee only and don’t get one penny from the buying and selling of securities in your accounts. The winners are the custodian and broker dealers who get the trading fees. Also the SEC, the federal government, gets a very small slice of many trades. Years ago clients received yearly statements, then it went to quarterly, the broker dealers and custodians made more money…then statements were sent out every month. It is expensive to send out statements every month but is very much worth it because of all of the emotion and therefore trading it generates. Next, to generate even more trading fees, they went to allowing online access. Finally, they went to sending you an email confirmation every time a change is made in your account! Now what are they going to do next? Maybe they should invest in having an automatic phone call that sounds off a bullhorn when the investor answers and has a person on the other end talking in a real fast voice with information about the recent trade. One thing that buy and hold and active money managers and financial advisors agree on is that the emotions of an investor, if acted on, ruin their returns!

Nobody Knows But God

   Another great piece to this same article actually reinforces the theory of Ecclesiastes 11:2, which says that no one knows the future. Here is what the article says, “Attendees at the National Conference in May got some perspective on the matter from Christopher C. Davis, chairman and co-portfolio manager, Davis Advisors. But Davis warned that firm answers are hard to come by. “You can address these questions rather than answer them,” he said. “The trouble is that a lot of questions clients ask, you can’t answer honestly. You desperately want to give an answer – it feels almost unprofessional not to give an answer…But it’s really a parlor game. No information that you can give in answer to the question is honest, except to say, ‘We don’t’ know.” This is in reference to the question, “Are we going to see a double dip recession?”

Buy and Hold May Win, Sometimes, In Short Term
   
The buy and hold philosophy for investing may outperform active management during certain years where there is no clear trend like in 2005 and 2007. However, because years like 2002 and 2008 do come around, a successful trading plan will far outperform the buy and hold strategy over a longer time period. By the way, even in years like 2005 and 2007 the possible outperformance of the buy and hold strategy is not guaranteed and minimal. I actively manage your accounts so you will have more money at the end because you have avoided the big drops caused by the emotional majority (the herd).

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Eleven Two Fund Management is a Registered Investment Advisor (RIA) located in Marietta, GA. We are proud to be working with Christian Individuals, small business owners, and Families in over 16 states.