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Why everyone gets confused about investing

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Thursday May 12, 2011 at 9:00am

Most people find investing noisy, confusing and full of mixed messages such as which fund manager is the best, how to beat the market, what the market will do next and how to time it so you buy high and sell low. It is not surprising when you see the resources stacked against clear thinking. Newspapers, TV, radio, advertising push individual funds, fund managers, sectors and regions. Even radio 4 tells us what the FTSE 100 did today as though this actually means anything to anyone other than a day trader.

Banks and investment managers push research claiming ability in stock picking and highly qualified mathematicians and economists with models giving them the foresight to time the market. Fund managers push their expertise and carefully pick the time period to show how their funds appear in the top quartile. And what’s more it is all paid for by the investor.

It wouldn’t be so bad if the industry actually delivered market beating returns but research has shown that this simply is not the case. A Dalbar study of American investor returns in the 20 year period to December 2009 showed that the average equity fund investor earned 3.2% annually compared to 8.2% for the S&P 500 Index. The average bond fund investor earned 1% annually compared to the Barclays U.S. Aggregate Bond Index which returned 7%.

In other words the average equity fund investor just about beat inflation maintaining the purchasing power of their money but not actually increasing the value in real terms. The bond fund investor saw a reduction in their wealth in real terms.

The reason for this is that most people rush to invest when the price is high and sell when the price is low. Investments must be the only purchase that seems most attractive when the price is highest and unattractive when they are cheap.

The reason for this is emotion. This is exhibited in several forms including: overconfidence, once we have made an investment we then look on it more favourably and believe it will do well. We also tend to extrapolate a rising stock market into ever higher prices and forget that past performance is not indicative of future results. As human beings we also shortcut decisions by going with the herd, thinking that everyone else must be right. We also suffer from a fear of regret which makes us reluctant to make investments in case prices fall or the investment does not meet our expectations.

And so it is not really surprising that people are confused about investing. They have the media and the industry as represented by fund manager and large financial institutions and banks hyping funds and pushing the message that picking stocks and timing the market will achieve market beating results. However, a combination of high charges and investor emotion means that most investors barely keep pace with inflation at best.

It does not have to be like this, in my next blogs I will explain why.

Andy Parker
Chartered Financial Planner Birmingham

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Parker Chartered Accountants and Financial Advisors is the trading name for Parker Business Development Ltd (Registered No. 4116664), Parker Tax and Trust Ltd (Registered No. 06950353) and Parker Financial Planning LLP (Registered No. OC347027). Parker Financial Planning LLP is authorised and regulated by the Financial Conduct Authority. All companies are registered in England and Wales – registered office contact details here