If You Do What You've Always Done, You'll Get What You Always Got

Published in Investing on 28 June 2012

To kick-start your returns, you need to kick-start your thinking.

As I've remarked before, the performance of many -- if not most -- private investors is shockingly bad.

Simply put, they buy the wrong stocks or funds, at the wrong time, and at the wrong price. And then they sell them, usually for minuscule gains. Or indeed, a loss.

Sounds familiar? You're not alone.

Lacklustre

A 2007 study of UK investors over the period 1992-2003 found that as a result of such money-losing decisions, investors' returns were around two percentage points a year lower than the funds in which they were invested.

Similarly, as investment author Tim Hale has pointed out in Smarter Investing, during the period 1984-2002 -- a bull market when the equity markets turned $100 of spending power into $500 -- private investors succeeded in turning that same $100 into just $90.

And one of my favourite illustrations of this wealth destruction in action comes from Prof Daniel Kahneman who, with his colleague Amos Tversky, laid the bedrock on which a lot of behavioural economics is based.

In his current best-seller Thinking, Fast and Slow, Prof Kahneman has this to say of research by Brad Barber and Terry Odean, which analysed the trading records of 10,000 brokerage accounts of individual investors spanning a seven-year period:

"On average, the shares that individual traders sold did better than those they bought, by a very substantial margin: 3.2 percentage points per year, above and beyond the significant costs of executing the trades... It is clear that for the large majority of individual investors, taking a shower and doing nothing would have been a better policy than implementing the ideas that came to their minds."

So how can investors break out from this endless treadmill of wealth destruction? As it happens, a couple of thoughts come to mind.

Know what you're doing

One is the importance of having a strategy, rather than reacting to the latest fad, Sunday newspaper share tip or bulletin board gossip. Plan the buy, in short, and then buy the plan.

And in my years on the Fool's discussion boards, I've long since lost count of the investors whose portfolios turn out to be a motley ragbag of all sorts of shares -- income picks, oilies, hi-tech growth picks, a scattering of blue chips, and the usual clutch of over-hyped funds.

In such cases, it's difficult to discern even the glimmerings of a plan, and quite often, it seems, there simply wasn't one. They all looked good at the time.

And one thing's for sure: the world's most successful investors don't operate like that. Of all the sage investing advice associated with Warren Buffett, for instance, a particular personal favourite of mine is Buffett's notion of a punched card with 20 slots, limiting the lifetime number of investment picks that you can make to 20.

As a 'thought model', it forces you to be far less reactive, and to make a properly researched investment case for each pick. And if a prospective pick doesn't pass muster, you don't buy. Arguably the world's greatest value investor, Buffett strives to buy shares that aren't just relatively cheap, but which are cheap in absolute terms, too.

And what's Buffett buying now? A share that I, too, have been loading-up on -- and one that I'll be buying still more of in mid-July, when I've banked my dividends from Sainsbury (LSE: SBRY), Marks & Spencer (LSE: MKS), GlaxoSmithKline (LSE: GSK) and BP (LSE: BP).

Its name? You can find that out in this free special report from the Motley Fool -- "The One UK Share Warren Buffett Loves" -- which also highlights the investment case that is likely to be exciting Buffett. The report is free, so why not download a copy now?

Masterly inactivity

Another oft-quoted Buffett saying -- albeit one that is usually cited incompletely -- is the remark that "our favourite holding period is forever".

And for many private investors, it seems that the exact opposite applies. Indeed, the research by Barber and Odean that I mentioned above -- pithily entitled Trading is Hazardous to Your Wealth -- found that those investors that traded the most earned an annual return of 11.4%, during a period in which the market returned 17.9%. That's a shocking degree of under-performance.

And for me, one of the huge strengths of the High Yield Portfolio approach popularised by my colleague Stephen Bland is its emphasis on inactivity. Famously, 'Doris' -- his muse -- simply held on to the shares she had, banking the dividends, and ignored market noise over the subsequent decades.

'Strategic ignorance' is the term that Stephen coined to encapsulate this idea that you should filter out market noise that you aren't competent to judge. And judging from the debates that spring up from time to time about its merits, it's one that some private investors find difficult to come to terms with.

Yet the evidence from Barber and Odean -- and further afield -- is clear. To repeat, as Prof Kahneman neatly puts it:

"It is clear that for the large majority of individual investors, taking a shower and doing nothing would have been a better policy than implementing the ideas that came to their minds."

That said, what Stephen didn't mean was pick a bunch of shares at random, and hold on grimly, regardless. In short, we're back to a strategy -- and in Stephen's case, in this particular instance, high-yield investing.

But there are other strategies in the play book, and other places to look outside the ranks of big-cap FTSE 100 (UKX) giants.

Indeed, in this free special report from The Motley Fool -- "Top Sectors Of 2012" -- you'll find the outlines of no fewer than three separate strategies, one for each of the three sectors covered. Several of the shares profiled, in fact, are ones that I hold myself, and two are shares that I bought for the first time after reading the report. You can download a copy here. And as I say, it's free.

Are you looking to profit from this uncertain economy? "10 Steps To Making A Million In The Market" is the very latest Motley Fool guide to help Britain invest. Better. We urge you to read the report today -- it's free.

More investing ideas from Malcolm Wheatley:

> Malcolm holds shares in Sainsbury, Marks & Spencer, GlaxoSmithKline and BP.

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