PERSPECTIVES
The Return Gap
The Return an Investment Generates Is Not Always the Return an Investor Receives
Most investors focus on investment returns.
Sophisticated investors understand that the return an investment generates is not always the return an investor ultimately receives.
The difference is often not fees, tax or markets.
It is behaviour.
Periods of market uncertainty can lead investors to make decisions that feel sensible in the moment but prove costly over time. Selling after a market decline, delaying the deployment of capital during periods of pessimism, chasing recent winners or becoming overly concentrated in a single theme are all common examples.
These decisions are rarely driven by a lack of intelligence. More often, they are a natural response to uncertainty, volatility and emotion.
Over time, however, the cumulative impact can be significant. Two investors may have access to the same investment opportunities yet achieve very different outcomes because their behaviour differs during periods of stress or euphoria.
At S.AG Private, we believe successful investing is rarely determined by a single market call. It is the cumulative outcome of asset allocation, manager selection, portfolio construction, risk management and behavioural discipline working together over time.
A significant part of our role is helping clients navigate uncertainty without allowing short-term emotions to compromise long-term objectives. This includes maintaining disciplined portfolio construction, avoiding unnecessary concentration, managing risk appropriately and remaining focused on the decisions that matter most.
Markets will always fluctuate. Headlines will always create uncertainty.
The challenge is not eliminating volatility.
The challenge is ensuring that volatility does not lead to poor decisions.
Ultimately, the objective is not simply to generate attractive investment returns. It is to help clients capture those returns by remaining disciplined through changing market conditions.
That is how the return gap is reduced.
Curious Investor Behaviours
Of all the challenges an investor faces, the most difficult to overcome are often those in our psychology. To be effective in the stock market, we need to guard our irrational instincts and program ourselves to avoid those behavioural pitfalls....
Anchoring: Faced with uncertainty, investors will grasp at any fixed point of reference when forming opinions. In a classic experiment, behavioural psychologists Kahneman and Tversky asked two groups to guess the proportion of African nations that make up the UN. The first group was asked whether the answer was higher or lower than 10%, while the second group was asked whether it was higher or lower than 65%. The median response of the first group was 25% and the second group 45%. Can you imagine the perils of anchoring investment decisions on completely irrelevant information?
Loss aversion: According to empirical evidence, the pain of losing $100 is felt more than twice as much as the pleasure of gaining the same amount (Kahneman and Tversky, 1992). Sadly, this irrational approach is evident I the stock market. Many investors keep hanging on to losing stocks in the hope that, some day, somehow, they will bounce back. Such is the distaste for loss that it causes a mental freeze which renders people incapable of sound judgement. Loss aversion is a common condition. Think about it – facing a loss, do you sometimes freeze and refuse to acknowledge reality?
Herding: When investors are uncertain about the value of financial instruments, they typically default to a herding impulse; part of our evolutionary heritage that serves us well in the past. Sadly, herds are ruled by the majority, so the prevailing mood predominates. It takes a healthy dose of scepticism and nerves of steel to resist the temptation to run with the herd. Perhaps we ought to keep reminding ourselves that a consensus view isn’t always necessarily right.
Phase myopia: At different phases of the market, our perspective changes. In the steepening down phase there is a tendency to take an ever-narrower view of the facts, focusing on near-term risk rather than longer-term reward. Conversely, a developing bull market inspires an ever-more extravagant view of opportunities. Have you ever found yourself suffering from this condition?
Noise Factor: The loudest and the most recent information clouds our judgement – even professionals fall for it. How do you correctly weight what you see and hear?