Invest
Why investors should ‘buy and hold’
While investors may like to think of themselves as absolutely rational creatures, the opposite is generally true. Adopting a ‘buy and hold’ strategy, however, may help investors make better decisions.
Why investors should ‘buy and hold’
While investors may like to think of themselves as absolutely rational creatures, the opposite is generally true. Adopting a ‘buy and hold’ strategy, however, may help investors make better decisions.
Investor behaviour often appears to defy all logic and reason. Why? According to research in behavioural finance, most investors are not strictly rational.
Rather, they are subject to behavioural biases. Past experiences, personal beliefs and preferences can influence judgment and skew decisions.
These biases can steer them away from logical, long-term thinking and deter them from reaching their long-term investment goals.
In a report, Capital Group studied two common behavioural biases – loss aversion and herd mentality.
The report examined their impact on investment returns and considered how long-term investing can help mitigate these biases and produce better investment outcomes.
The study makes a strong case for long-term investing, particularly in relation to buying and holding sound investments.
More importantly, it’s time to put new focus on long-term investing and how it can create meaningful value for the investor.
Behavioural pitfalls
Behavioural finance contends that when it comes to investing, people often exhibit herding behaviour or a ‘group think’ mentality.
They mimic the behaviour of others, especially in times of uncertainty. But the majority is not always right.
Besides, basing your investment decisions on the actions of others makes little sense given different investment goals and financial circumstances.
Most investors are also loss averse. According to research by Nobel laureate Daniel Kahneman and his late collaborator Amos Tversky, losses hurt about two to 2.5 times more than gains satisfy.
Put another way, the pain of losing $10,000 is disproportionately greater than the pleasure of winning $10,000 Most people need a potential gain of around $20,000 to $25,000 to balance the risk of losing $10,000.
This asymmetry can lead to panic selling during severe market setbacks.
Effects of loss aversion and herding on investment returns
If behavioural biases can influence financial decisions, what subsequent impact would that have on investment returns?
We sought to answer this question by studying the effects of loss aversion and herding on investment returns.
To be as comprehensive as possible, we analysed multiple scenarios using a loss aversion ratio of 2.5 times and covered a total of 301 rolling periods.
For the purpose of this study, we focused on three scenarios – investors with high, moderate and low loss aversion, leading to high, moderate and low trading frequency respectively, and compared them with a buy and hold scenario.
The results were striking. Buy and hold investors can earn much better returns when compared with those who move in and out of markets.
Over the average 20-year rolling period between 1970 and 2014, their initial investment of $100,000 would have had an ending value of $845,162.
By contrast, highly loss-averse investors would have gained $593,974 or 30 per cent less, while those with low loss aversion produced an ending value of $521,275 or 38 per cent less.
The case for selectivity
Buy and hold can yield greater value over the long term – that is the conclusion drawn from our analysis of market returns over the past decades.
It helps, therefore, that there are skilled active managers who are better oriented to downside resilience and low volatility, both of which can counter behavioural biases. Passive index investors, by contrast, bear the full brunt of market declines.
That is also why we stress a long-term perspective and the importance of preserving capital during downturns.
We believe that by producing results that are less volatile than the broader market, investors are less likely to react to fluctuating market conditions by making short-term decisions with potentially destructive long-term consequences.
The active advantage
Another plus about active management is that certain actively managed portfolios can provide the added advantage as compounding excess returns over time can lead to significantly higher returns for the investor with a long-time horizon.
That, in our opinion, points to the potential value of active management.
Picking solid companies, backed by a well thought out, in-depth global research process which combines fundamental, on the ground research with comprehensive macro analysis can serve the long-term interests of investors very well.
The flip side, though, is that the cost of panic selling can be considerably larger.
Investors who exited funds during the global financial crisis and stayed out because of loss aversion missed out on rebounds as high as 95 per cent five years later.
Equally, investors who reacted emotionally on the back of loss aversion and herding suffered big losses.
These outcomes make a strong case for buying and holding solid portfolios which generate more favourable long-term returns, with lower volatility.
Their downside protection keeps investors from being overly irrational, while their strong rebounds reward investors’ patience.
The benefits of such a powerful combination cannot be overstated.
Andy Budden, investment director,Capital Group
Stock market
Could this bull market be losing steam?
There’s an old investment adage that bull markets never die of old age, with the current market showing signs of cracking just months after the recovery, an industry expert warns. ...Read more
Stock market
Super fund investors bid to acquire Sydney Airport
A group of super fund investors has lodged a non-binding takeover bid for Sydney Airport, valuing the company at over $22 billion. ...Read more
Stock market
10 most globally held stocks revealed
Australian investors remain bullish on electric vehicles and technology stocks, according to their long-term held positions, new research has shown. ...Read more
Stock market
How ‘gamer investors’ are pushing a new wave of social responsibility
A new generation of younger retail investors are pushing a new social movement, yielding a distributive impact on the markets, most notably through the GameStop saga, two researchers have revealed. ...Read more
Stock market
ASX tipped for record high despite inflation fears
The market is tipped to shake off fears of rising inflation, with the ASX 200 now tipped to close the year at a new record high, an economist has revealed. ...Read more
Stock market
‘Commission-free propaganda’: Warning issued for retail investors
The phrase “if you’re not paying for it, you’re the product” applies just as much to stock trading apps as it does to social media networks. ...Read more
Stock market
Is the tech sell-off creating opportunities for investors?
A tech sell-off sparked by inflation concerns has seen world markets crash. But is it creating an opportunity for investors to ‘buy the dip’? ...Read more
Stock market
Government opens arms to Wall Street
In its bid to maintain Australia’s global competitiveness, albeit its firmly shut borders, the Australian government has included a measure in its recent budget to allow foreign financial services p...Read more
The Olympic effect on property and equity investors; COVID-19 Disaster Payments and super
Listen now
Do lockdowns boost property prices? Are short-sellers levelling the playing field? Did you lodge your tax returns early?
Listen now
Will lockdowns halt the housing boom? Is the metaverse taking over? And the cons of lodging your tax returns early
Listen now
Are you being priced out of the market? Have you got the Tuesday blues? And are you ready for the upcoming super changes?
Listen now
Stock market
Could this bull market be losing steam?
There’s an old investment adage that bull markets never die of old age, with the current market showing signs of cracking just months after the recovery, an industry expert warns. ...Read more
Stock market
Super fund investors bid to acquire Sydney Airport
A group of super fund investors has lodged a non-binding takeover bid for Sydney Airport, valuing the company at over $22 billion. ...Read more
Stock market
10 most globally held stocks revealed
Australian investors remain bullish on electric vehicles and technology stocks, according to their long-term held positions, new research has shown. ...Read more
Stock market
How ‘gamer investors’ are pushing a new wave of social responsibility
A new generation of younger retail investors are pushing a new social movement, yielding a distributive impact on the markets, most notably through the GameStop saga, two researchers have revealed. ...Read more
Stock market
ASX tipped for record high despite inflation fears
The market is tipped to shake off fears of rising inflation, with the ASX 200 now tipped to close the year at a new record high, an economist has revealed. ...Read more
Stock market
‘Commission-free propaganda’: Warning issued for retail investors
The phrase “if you’re not paying for it, you’re the product” applies just as much to stock trading apps as it does to social media networks. ...Read more
Stock market
Is the tech sell-off creating opportunities for investors?
A tech sell-off sparked by inflation concerns has seen world markets crash. But is it creating an opportunity for investors to ‘buy the dip’? ...Read more
Stock market
Government opens arms to Wall Street
In its bid to maintain Australia’s global competitiveness, albeit its firmly shut borders, the Australian government has included a measure in its recent budget to allow foreign financial services p...Read more
More articles
Website Notifications
Get notifications in real-time for staying up to date with content that matters to you.
