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VIEWPOINT: GUESS RIGHT RATIO

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It seems the typical South African unit trust investor, like Bill Murray’s character in Groundhog Day, is condemned to underperform the market year after year.

According to DALBAR 2014, in general, investors make money when the ‘guess right ratio’ exceeds 50%. Following on last month’s overview of the 2014 DALBAR’s Quantitative Analysis of Investor Behavior (QAIB), I thought that investors may be interested in a little further insight into how to fine-tune their investment skills.  Since 1994, QAIB has been measuring the effects of investor decisions to buy, sell and switch between unit trusts over both short- and long-term timeframes. The results consistently show that the average investor earns less – in many cases substantially less – than the market indices.

In analysing investors’ decision-making behaviour, and the timing of their transactions, DALBAR have established its ‘guess right ratio’. It shows that investors responding to anything other than a prudent investment decision reduce the return created by the markets.

IS INVESTOR EDUCATION FUTILE?

DALBAR’s research tracked investor returns against the S&P 500 during the rising markets of 2013 – in particular the best six months. Investors guessed right 75% of the time, yet still trailed the index by 6,87%.The explanation is that though investors were generally making the right guesses, they were unsuccessful in timing the market. Tracking monthly investment flows that year showed that there were no large upticks of inflows before the best-performing months of the year.  It then begged the question of the cost of guessing incorrectly.

Their research also found that ‘one of the most startling and ongoing facts is that at no point in time have average investors remained invested for sufficiently long periods to derive the benefits of the investment markets’.The conundrum is that their research found that to avoid underperforming the markets, investors need to guess correctly more often than incorrectly but simultaneously concluded that this was unachievable, and only increased the ‘folly of market timing’.  However, it suggested an alternative – rather avoid trying to time the markets by focusing on a long-term holding strategy.

So the next time you feel the urge to react immediately to market indices and headline news, the research suggests that maybe you should avoid trying to ‘outguess’ and ‘out-time’ the market.

Author: Mike Lledo CA(SA) is the CEO at Consolidated Financial Planning