“Experience is the toughest teacher because it gives the test first and the lesson later.”
It is so easy for anyone to open a brokerage account, or a futures account and just start trading or investing. While I admire the spirit of independence and self-reliance that leads non-professional investors to manage their own money, the statistics suggest that very few are successful. For example, in the futures markets, we have weekly data on all the positions in aggregate for 3 different classes of investors. There are 2 separate classes of professional trader, and then the Small Speculative (SS) positions of the remainder. These are the non-professional investors. The chart below shows the S&P; 500 index and the net positions of the SS.
Clearly, this chart shows that SS traders in aggregate usually have the wrong position at the major turning points. The red triangles highlight the points at which they had maximum long positions. In each case, these positions marked a significant high for the market. Somewhat disturbingly they are once again at an extremely long position.
This is not just a one-off finding for SS traders who trade S&P; 500 futures in the last 5 years. The same analysis held true across 43 different commodities traded over the last 13 years. The conclusion is inescapable. Most non-professional futures traders lose money over time. Most self-directed investors, however, do not necessarily trade futures, but does this mean they fair any better?
Another class of self-directed investors is mutual fund investors. How well does this group do? Not so good says John Bogle, and he should know. He was former Chairman and founder of Vanguard, one of the largest mutual fund groups in the world. Why is this you might ask? Well, there may be many reasons but clearly, the main problems are the level of expenses in mutual funds, and “investor behavior.”
This table shows it all. The Quantitative Analysis of Investor Behavior (QAIB) is compiled regularly by Dalbar, a leading financial services market research firm. Whatever period you look at, the relative performance is much the same. The difference between the performance of the S&P500; and the average fund, here 3.2% (16.3% – 13.1% from the bar chart) per annum, largely represents the expenses of investing in mutual funds. The gap between the average fund return and the performance of the average fund investor, here 7.8% (13.1% – 5.3% from the bar chart) per annum, is put down to investor behavior.
Whatever the reason, it is also clear that once again self-directed investors in aggregate experience very poor performance. We have covered surely the most active and involved investors, who trade futures, as well as the most passive, who just stick to mutual funds. So it is highly likely that what we have seen from these two sets of results covers the full spectrum of self-directed investors. There are always exceptions but clearly, very poor results are clearly the norm.
Investors, therefore, need to inform themselves of what is needed to become successful and decide whether this is realistically within their grasp, whether from a time commitment point of view or for any other reason. Certainly, one starting point is to consider what the most successful investors suggest is needed.
The evidence above strongly suggests that self-directed investors need to take great care in how they proceed, as they will need to separate themselves from the average if they are to have any chance of long-term success. So what are the key factors that will lead to success? While libraries have been filled trying to answer this question, I believe that there are at least a few common factors that any successful investor needs to address.
Here are a few of them:
Just because I am an Investment Advisor does not mean that I am against people becoming self-directed investors. I myself have chosen this path and after twenty years I have learned a great deal about what it takes to become successful, and I am still learning and always will be. It is a great lifetime occupation for the right kind of person.
However, like most occupations, it is not for everyone. So I hope that investors think carefully about what their approach is to this particular venture. It is important that investors think clearly about their investment needs as well as their direct involvement. Not only your motivation but also your aptitude and commitment need to be appropriately aligned if you are to have any realistic chance of achieving long-term investment success as a self-directed investor.