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Money: The connection between investing and snoring

14 Aug 2018

In a June 1999 interview, Warren Buffett, one of the most famous investors of all time, said, “Success in investing doesn’t correlate with IQ. Once you have ordinary intelligence, what you need is the temperament to control urges that get other people in trouble investing.”

Larry Swedroe, a writer on finance, takes up the theme in ETF.com. Larry makes the point that investment markets test investor discipline with periods, often long ones, of poor performance. “In my more than 20 years of counselling investors, I’ve learned that, when it comes to judging investment performance, most investors think three years is a long time, five years is a very long time and ten years is an eternity,” says Larry.

In investment research we know that ten years is more likely to be ‘noise’ and investment returns over this time period should not be over-rated.

To quote Warren Buffett again, “We continue to make more money when snoring than when … we are actively buying and selling investments.”

Many investors are tossed around by worrying stories in the news media even though they know they shouldn’t worry. It is a normal human experience to remember the last thing we’ve been told and let it get to us (the recency effect). Everyone is tested by bad news that show us losing money, even though it is only temporary. The voice in our head tells us that it might be different this time and maybe markets won’t recover.

Larry Swedroe gives the following example of the introduction of small company value investing as an investment strategy. This came about as the result of research that Fama and French published in their 1992 paper. Soon after, Dimensional Fund Advisors launched the first small company value fund. Almost immediately investor discipline was tested. For the next 7 years the small value fund underperformed the main index (S&P 500) by 6% per annum on average. Over that period the small value fund produced a total of 153% while the main index produced 265%. This period is not alone. Over the past 5.5 years to 30 June 2018 the small company value fund has produced a 38% return versus a 61% return for the main index.

This sort of under-performance would test our clients’ resolve, especially the most intelligent of them, who tell me they judge our performance against our peers over a typical five-year period. The ‘smart money’ believes that five years is a reasonable time period to compare returns over. KiwiSaver commentators do it all the time causing considerable damage as a result. I know that a decent number of KiwiSaver investors make investment decisions based on the past five-year returns.

To get to the point of our small company value fund that suffered those two long periods of under-performance – what is the overall position of the fund since inception (25 years)? Data from Dimensional tells us that the annual compound return has been 12.0% per annum for the small value fund while the main share market index has produced an annual compound return of 9.5% per annum.

Discipline has been rewarded.

Warren Buffett again, “My favourite time-frame for investing is forever.”

Keep asking great questions …

Read more articles in this fortnight's edition of 'News Farmers Can Use': 

P.S. Disclosure - we use Dimensional Fund Advisors as one of our key fund managers and we include small company and value company allocations in our client portfolios.