Don't mistake a bull market for genius We can’t all be above average!

A bull market can make investors over-confident and take too much risk. You don't need to. Being just a shade better than average on a consistent basis will add a lot of value over the long-term.

 We can’t all be above average!

Surveys show that the majority of drivers believe they have well above average ability behind the wheel. This quirk of human nature holds a lesson for us investors.

The reason why we laugh at that survey (despite privately believing that we are indeed in the top echelon of drivers!), is because we know that it’s plain silly for everyone to be ‘above average’. Most people are clustered around the median, with some a bit better and some a bit worse. There are always outliers, but they have a rare talent, as evidenced by Lewis Hamilton‘s £33 million earnings last year.

Benign conditions

However it’s also easy for investors to believe themselves to be of ‘above average’ ability behind the dealing screen. Especially when conditions have been as benign as they have during the last 12 months, which have seen the AIM index rise by 30 per cent.

In contrast with last year, 2017 so far has seen a market in which good quality small cap stocks have done well. And I imagine most private investors have been enjoying themselves. I draw a contrast with last year because 2016 was a lot tougher for stock-pickers, despite the FTSE All Share index returning almost 17 per cent. I’ve been measuring my own personal account’s performance for the last 13 years and 2016 was one of only two years (the other being 2011) when I’ve been behind the benchmark. As an aside, our GCI Portfolio did extremely well last year, so maybe I should just replicate it for my personal accounts!

Unearned

My point though is that market conditions can provide us with an ‘unearned’ boost, or drag, on our performance. It’s important to recognise this when it happens. That way we don’t get carried away thinking we’re Warren Buffett during a good year, nor do we despair and throw in the towel when conditions are difficult. Keeping on an emotional even keel is crucial for long term success.

Added value

The good news is that we don’t need to be an outlier like Buffett to be a successful investor. In fact, being average is OK because the market goes up over time – so in that way everyone’s a winner. And the power of compounding returns over long periods means that being just a little bit above average in most years will result in a lot of added value. For example, if equities generate a long-run average return of 8 per cent a year (inflation of 2% + yield of 3% + dividend growth of 3%), then after 20 years a £100,000 stake would be worth £460,000. If we can beat that by adding just 1 per cent more each year, we’d have an extra £100,000.    

Genius is rare

However when things are going well the temptation is to push it and take more risk. In fact we confuse being in a bull market with investment genius! Whereas we would be better advised to remember that favourable conditions don’t last forever, and more than ever we need to watch out for a change in the investment climate.

Back to driving – currently it’s like we’re taking a bend rapidly in perfect road conditions behind the wheel of an Aston Martin. It feels great. But on our next outing the surface might be damp and the tyres on our Dacia worn. With the result being we end up wrapped around a tree.

Comments (0)