The Importance of a Disciplined Investment Approach

Study after study has shown that most individual investors have poor returns investing on their own.  A recent study showing this was done by Dalbar Inc.  For the twenty years ending 12/31/2015 the S&P 500 Index averaged 9.85% per year.  The average equity fund investor earned a return of only 5.19% in comparison^[1].  Why is there such a measurable difference?

Investing is as much of an emotional game as it is anything else.  Other than family, finances and money are as personal of an asset as you can have.  As a result, people tend to make decisions that are driven by emotion as opposed to facts and data.  Note the market cycle of emotions from Russell Investments below:

The reason for the drastic underperformance is because the times where it feels best to invest are usually the worst! At the excitement and thrill stage of the market cycle people are making money and think it will never stop.  As a result, this is a classic case of buying at the top – the worst possible time to make an investment.  Conversely, at the point of despondency after the market has gone down, investors are feeling depressed and pessimistic.  They play out scenarios in their mind that things will keep getting worse and end up selling at the worst possible time!  This kind of behavior is akin to buying something full price at the store and then returning it when it is on sale and getting a lesser price back for it.  Nobody would ever consistently do that, but people do that with their investments all the time!

I would like to say that in my line of work financial advisors are immune from such faulty thinking.  In my 13 years at a sizable branch of a large wirehouse firm I had the opportunity to talk with many advisors each day about what moves they were making in client portfolios.  What I noticed throughout conversations over the years is that there were a few financial advisors that did not succumb to the emotional pressure but many advisors were just as emotional about making decisions as clients!  Case in point a CNBC article published on April 8, 2020 said that 81% of financial advisors polled by Ned Davis Research continued to see the markets heading lower^[2].  Obviously, the coronavirus market crash of 2020 was about as volatile and emotional a move in the financial markets as anyone has seen in their lifetime.  Instead of using what was arguably one of the best buying opportunities in quite some time to buy, 8 out of 10 of these financial advisors got it wrong!  This was in part due to the emotional nature of the shutdowns and market environment.  Someone using a qualitative approach could have been able to see that extreme negative sentiment, increases in the money supply, and high insider stocks purchases among other things were possible reasons to put emotion aside and either stay invested or make additional purchases.

One of my favorite sources of data on qualitative and statistical approaches to the financial markets comes from the Connors Group.  In his book, How Markets Really Work, Larry Connors shows many rigorous studies on buying at price highs and lows using various technical indicators and methods.  The one thing his research has consistently shown is that buying after the market has gone down (there are many ways to quantify this but all show the same general theme) has drastically outperformed buying the market after it has risen.

Markets go through various cycles and can produce many different emotions.  Some of the most successful investors are the ones that develop the ability to pause, reflect, and practice the classic adage of buy low, sell high.  I believe mastering these emotions are critical for investment success and it is important that both you and your financial advisor use a quantitative and qualitative approach that steers free of making poor emotional decisions.

Robert David

Portfolio Manager & Financial Advisor

Bluewater Investment Strategies, a member of Advisory Services Network, LLC