You’re paying for your ignorance

Posted in Blog
01/06/2020 Mduduzi Luthuli

The problem with most people is that they don’t believe that they are capable of understanding financial markets. They don’t believe in their ability to become a good investor over time and wrongly accept that the stock market is simply beyond their cognitive capability.

If you’re one of those people, I’m here to tell you that you’re WRONG.

If you can read, develop the necessary discipline, and have a reliable internet connection, you have all the tools you’ll ever need to become a competent investor. I know investing can seem like an intimidating business, encrusted as it is with jargon, but that is no reason to be put off. In fact, one could argue that insecurity is an advantage a novice investor holds over the professionals.

Sometimes the best investing strategy is to sit tight and see what happens. After all, it is very hard to predict how markets will fluctuate in the short term and investing is for the long term. Doing nothing and not reacting to market movements can be much easier if you are not overly confident – a lack of conviction that you know which way markets will go next or how to respond can lead to inertia.

As our confidence grows, it gets harder not to meddle. We start to think that we know better than others and so we start to change our portfolios based on our predictions – whether they are right or not. And making quick changes will be unlikely to produce a good outcome on balance. It has also been found that over-confidence encourages us to take on higher levels of investment risk if we believe we can predict what will happen in the market more accurately than others.

A study by professors Barber and Odean at the University of California laid bare the cost of overconfidence leading to over-trading. Over a 6-year period, professors Barber and Odean carried out detailed research on more than 78,000 US brokerage accounts, analysing over 3 million trades. Specifically, they wanted to understand how investment returns differed for the 20% of investors who traded the most compared to the 20% who traded the least.  

The results were truly shocking.

The confident, frequent traders achieved returns of 11.4% a year compared to 18.5% a year for the less active traders. To put this into perspective, $1,000 invested at the beginning of the period would have grown to over $2,700 after six years for the active traders, compared to over $4,000 for the infrequent traders.

You can keep it simple — and simple is good. Fund managers need to attract funds and fees with theories, names and performance that make them stand apart. But despite all this, many will not do any better than cheap, passive funds that are not actively managed, once fees are factored in.

It’s human nature that we’re attracted to things – especially in investing – that sound more complicated and believe they will yield better results. It makes us feel as if we’ve found something unique and special even though the data proves that the boring index or passive fund performance tends to beat most actively managed funds.

Diving into the theories and technicalities of investing is useful and necessary. Of course it is vital to understand what you are investing in. Take the time to educate yourself and become financially literate. Good advice will always be worth paying for, but you can develop the skills necessary to manage your own portfolio.

You’re paying for your ignorance.

Stop complaining about the fees you’re being charged if you’re not willing to take the time and make the necessary effort to educate yourself.  

Subscribe NowA monthly exploration of our relationship with money

Any fool can know. The point is to understand - Albert Einstein