Global investors are making three big mistakes - don't make the same ones!
Investors around the world, it seems, are falling into three traps, according to a major global survey by our employer, Schroders, that younger savers might want to avoid.
One: Reacting to stock market jitters
Many savers think that investing is about trying to time the stock market, but even the professionals struggle to do this.
Schroders’ Global Investor Study 2019 has shown that fewer than 20% of investors held their nerve and did not mess with their portfolio in response to stock market volatility in the final three months of 2018.
The survey of more than 25,000 respondents found that most investors (56%) reacted to the stock market falls by moving into lower-risk assets or by cashing in their equity-based investments.
There were indeed some hairy moments in that quarter, with global stocks suffering their worst quarterly falls in seven years at the end of 2018 amid global economic concerns, driven by ongoing trade tensions between the US and China.
But as the graph below shows, stock markets can very swiftly recover.
So those who bailed out in a panic in late 2018 will have probably sold at the bottom and lost out on the recovery - the opposite of what most investors want to do.
“No-one likes to lose money so it is not surprising that when markets go down investors feel nervous,” Schroders’ Personal Finance Director Claire Walsh said. “Research has repeatedly shown that investors feel the pain of loss far more strongly than the pleasure of gains. That can affect decision-making,” she added.
“As our study shows even just three months of rocky markets led many investors to make changes to what should have been long-term investment plans. That could potentially lead them into making classic investment mistakes. These include selling at the bottom when things feel bad or moving their money into cash in an attempt to protect their wealth, but then leaving it there too long when it can be eaten away by inflation over time.”
One good tactic for those concerned that markets might take a sudden turn for the worse is to drip-feed - in other words putting away a regular monthly amount into your portfolio. For most this is the only choice anyway as not many have the luxury of a big lump sum to chuck into the stock market all at once.
When stock market prices are high that monthly payment will buy less; when prices are low, you stock up on cheap investments. This goes a long way to riding out stock market volatility.
Likewise, those who are nervous about stock market falls should take financial advice and set a low-risk portfolio. But then don’t tinker in response to short and medium-term index movements.
Two: Taking a short-term view
The golden rule of investing is that it should be for the long term - which is at least five years and possibly even more than 10 years. This gives your investments a period over which most stock-market-based investments will show a positive return.
But the study revealed that the second mistake (which is closely related to the first) is that investors tend to take a relatively short-term view. On average, people stay invested for just 2.6 years before moving their money elsewhere or cashing in.
Just 13% of investors said they stayed invested for a minimum five-year period often recommended by financial advisers, while 41% said they stayed invested for a year or less.
“Generally speaking, the longer you invest for, the longer you have to ride out any bumps along the way, which is why it is suggested you invest for a minimum of five years,” Claire Walsh said.
“It is slightly concerning that such a large proportion of investors don’t do it. People do have different investment goals like buying a house or investing for retirement. However, if your goals are truly short-term, like perhaps buying a car, then maybe saving in a deposit account is a better option,” she added.
Here is where younger savers have the big advantage. The longer your investing horizon, the more you can relax. If you are putting money away that you will not need for 30 or 40 years, even big stock market corrections can be seen as buying opportunities rather than reasons to bail out. And you will also benefit from compound interest.
But don’t expect to be suddenly rich - which is where the third mistake kicks in.
Three: Unrealistic expectations
The study found that global investors expect returns of 10.7% over the next five years. And younger investors are the worst for being over optimistic: millennials (those born in the 1980s and 1990s) believe they can get an annual return of 11.5% over the next five years. The expectations decrease with each generation: Generation X (those born in the 1960s and 1970s) expect 10.8%; Baby Boomers (those born from 1946 until the early 1960s) expect 9.0%; and those aged 71 and over expect total returns of 7.8%.
The returns include growth in their money, as well as any income paid out in the form of dividends and interest from a variety of investments including cash, bonds, property funds and equities.
Now compare this to recent actualities: in the last five years global stocks, as measured by the MSCI World Index, have returned 6.7% annually. (It is worth noting that the historic performance of markets does not offer a guide to future returns).
Claire Walsh said: “The study reveals that younger people expect higher returns from their investments. That might be partly down to their investment time horizon. In theory, they have more time on their side and therefore could be willing to take more risk knowing that they still have time to recoup any losses. However, I suspect that this is possibly because younger people don’t have as much investment experience. For some they will have only known strong stock market returns and may have been influenced by this in their responses.
“Older generations are generally more risk averse and are likely to be more focused on protecting their investments for retirement. Taking less risk generally means accepting lower returns.”
Remember, this article is not a recommendation or advice. All investing comes with risk, the value of investments and the income from them may go down as well as up, and investors may not get back the amounts originally invested.
Read more: Is investing for me?