It has been interesting to observe how many people have opened a share trading account since lockdown. It is great to see people thinking about their money and investing for their future. Some of these investors have used the platform to set up diversified portfolios with broad asset allocations and industry exposure. In doing this, they hope to achieve returns that match the overall market’s performance. However, many investors are hunting for something sexier.
They are smart and believe they can outperform the market by strategically selecting the most promising shares. Are you in this boat?
If so, you might be feeling very good about how your investments have performed over the past 12 months. You might be thinking, “I have a bit of a hidden talent at this whole investing thing”.
It is possible that you are a skilled investor, who like Warren Buffet, will consistently choose great shares and beat the market. It is also possible that you have experienced great returns because you started investing during the lockdown, immediately following the worst calendar quarter in sixty years. Luck? Or skill?
An academic paper published by Hendrik Bessembinder, a finance professor at Arizona State University, looked at the US share market performance over a 90-year period ending December 2015. There are several interesting findings.
- Over their lifetime, 58% of shares underperformed one month Treasury bills, and a majority lost money.
- More than half of the individual shares delivered negative returns, and the average lifetime return of any single share was -3.7% per annum.
- The US share market has generated US$32 trillion of wealth, but all this wealth was generated by the top 4% of shares listed during that 90-year period.
Picking individual securities, i.e. shares, can be fun and entertaining, but you run the risk of missing out on the top 4% that will generate most of the returns. Bessembinder’s study is another powerful argument for broad diversification.
As I mentioned earlier, I think it is great that more people are interested in investing! But there is a lot of market noise, and I am concerned that some people could learn some expensive lessons.
You need to be clear on your reasons and objectives for investing. Have you purchased shares for fun and entertainment, as many of us did in our “1987 share clubs”? Or are you buying shares for you and your family’s long-term benefit? It is okay to speculate, but do not confuse it with investing.
To be a successful investor, you need a plan, a strategy, and an appropriate time horizon.
If you found this article interesting, you might also enjoy ‘Which Companies Are Going To Outperform the Market‘.
Andrew Nuttall is a Financial Adviser at Cambridge Partners, an independent and fee-only practice based in Christchurch. His disclosure statement is available on-demand and free of charge. www.cambridgepartners.co.nz telephone 364-9119.