Investing sounds simple: you pick some decent funds, set up a regular payment, wait and riches follow. Unfortunately it’s not that simple, and this is a lesson I’ve had to learn more than once. If you learn it now you can avoid this mistake costing you a fortune.
Oxford Risk research showed that UK investors lose around 3-4% a year from their own behaviour. At £200 a month invested from starting work at 20 to retiring at 70 that’s the difference between a million pound pot and £275k – £375k (assuming 7% returns). That’s not a small difference, that’s a completely different retirement.
Oxford Risk refer to this ‘actual’ return compared to what we could be making as anxiety adjusted returns. It points to this being the fear and emotions we have about investing are causing real damage to our investments. It is the real and measurable cost of being humans, rather than just being pure logic machines.
Where does the cost come from?
So where does that 3-4% actually go? I leaks out of your portfolio through a handful of behaviours we accidentally fall into without noticing. Four specific traps do most of the damage:
- Cash: Money saved in cash and cash-like can feel like investments, but are getting nowhere near the returns of other investments, and compared to inflation are usually losing you money. Cautious investors can often have most of their ‘investments’ in cash, costing them a fortune.
- Buy high sell high: When companies are doing well and their shares are soaring, you see the great profits people are making and want some of that too. Unfortunately that is when their share prices are high. When companies go through hard times and all the papers talk of doom and gloom you want to sell to stop all the losses you are making. Unfortunately this is when their share prices are low. We instinctively buy at the top of the market and sell at the bottom, which is the exact opposite of how you make money.
- Fear of the unknown: there’s a known ‘buy what you know’ motto investing, which means you can make good returns investing in areas you know well. The problem is, most investors don’t have detailed knowledge of any part of the industry, which can put them off investing in anything except a very narrow amount of investments. Here in the UK this usually results in most people only knowing about buy-to-let; we understand buying a house and people paying to live in it. The stock market is the big unknown, but avoiding it will cost you the great returns you can make from it.
- FOMO: the boring option may make you more money, but it’s less rewarding mentally to make money with the boring path of sensible index fund investing than to have made £100k on the latest crypto. You can make bad investing decisions trying to avoid regret at missing out on the big thing. Unfortunately the first option is much more likely to make you the £100k.
The case for investment advisers
A solution for this ‘cost of being human’ can be to pass all the decisions over to an investment advisor, who won’t have the same emotional response to your money and can invest more logically. It can cost 1-1.5% a year more than doing it yourself, but if you are getting 3-4% better returns you can afford that, that still gives you a 1.5-3% profit. They usually only take on clients who have some money, so this is likely not an option when you’re first starting out.
The good news
This actually makes your life a lot simpler. Invest in a decent global index fund, set up your monthly investment and then just leave it alone (channelling your inner Moss from The IT Crowd). This has historically given a 3-4% gain over the average UK investor every year.
There are huge benefits that can be made from automating your whole investing life. Make a good, strategic decision for how your money is to be invested over the next 10 years, set up the ISA, set up the automatic payments and automatic investments. You can then just get on with your life, and come back to your portfolio having done the hard work on its own. Easy life, better returns.