Why Investors Fail

Almost every investing study tells us that buying stocks at a low price to anything results in market beating performance. Even just buying a S&P ETF and doing nothing else beats most investors and mutual funds. If out performance is a matter of doing a few simple things and nothing else then why is everyone acting so crazy? And if earning market matching, or market beating results are so simple then why don't investors earn those sorts of returns?

Fidelity released a study discussing a performance breakdown for their accounts. The clients that did the best were the ones who were dead. The second best performing set of clients forgot they had Fidelity accounts. It seems like a formula to beat the market is to start an account, forget about it, then die. Your heirs will thank you and marvel at your investing prowess.

How is it that investing is so "easy", yet so hard?

If in theory all one needs to do is follow a few simple formulas, or invest in a few ETF's why aren't more investors matching or beating the market?

It's often said that investors are their own worst enemy. Our own emotions get the best of us. When the market is roaring higher we get excited. When the market hits new lows we're too depressed to even open our account statements.

I believe investors fail for a number of reasons with the biggest being the lack of patience. There are many investing strategies that make sense on paper. The problem is few investors have the patience to see these strategies through to the finish. It is more exciting to watch a stock jump up and down 2-3% a day, or see a battle ground stock bantered about on CNBC compared to owning a company that trades in tenths of a percentage point most days. The thing is those tenths add up over time, especially for companies that continue to execute operationally.

Finding a reasonable investing strategy isn't an issue, it's sticking to it

It is very easy to find undervalued investments, but holding onto those undervalued investments for years can be difficult. For many investors it's fun to research and watch holdings, but it's no fun to watch a stock effectively do nothing for days, months, or years. If the excitement is in the research then we'll continually be researching new positions and throwing out the old ones.

Investors also fail if they do too many things at once

A few net-nets, a few growth stocks, some shorts, a turnaround or two etc. Their portfolio is a potpourri of strategies, many of them that are complex and require dedicated skills. Each investor needs to find their own style and stick to it. There is a reason there are so many funds with one focus. It's much easier to be a bankruptcy fund, or a turnaround fund compared to a general value fund. The same is true for individual investors. It's much easier to focus on a specific corner of the market rather than invest in any and all things cheap.

Related to doing too much is researching too much. Some investors fail because they can't see the forest through the trees. They are so caught up in the minutia of an investment that they miss the big picture.

I enjoy reading message board posts related to investments I'm researching. I'm always on the lookout for what I consider the obsessive investor. For some reason these obsessive investors often congregate in oil and gas or mining stocks. You've probably seen these posts. A few books worth of material detailing the pressure of well bores the company had in North Dakota in 1988. Excited posts about how rumors are swirling that carpeting is being replace at headquarters and maybe it's a sign of a buyout.

Buried within the pages of notes are usually a few nuggets of information useful to an investment thesis. But my feeling is that the author probably has no idea, they are too consumed with finding out everything related to the company to realize this. The ultimate irony is that the body of knowledge an obsessed investor can accumulate is about the minimum amount of knowledge every middle level employee at the company has. In other words outside investors are always at a significant informational disadvantage to almost any company insider, even the lowest level employees at times.

My favorite investments are ones where the value is obvious and the investment rests on what I consider a few pivot points. These are general assumptions. The larger the gap between the current price and fair value combined with a small number of pivot points makes for investment success. This is because each assumption, each estimation, and each guess adds uncertainty to a model. At some point endless research can blind an investor from realizing what truly matters from what they think matters.

Once I realized that I didn't need compile an exhaustive list of company information to make good investments I began to simplify my research. I only researched what was necessary to confirm or deny the pivot points I'd identified with an investment. By doing this I saved myself the endless research. Maybe the carpet color does matter in a merger. Small details can be exciting. But it's the boring details that matter, such as the age of the CEO, or the age of the Board. Companies with graying executives and graying boards are more likely to sell their company.

Investors also fail because they don't really know what they own, or why they initially invested

Cloning investments is a very popular strategy right now. And like all investment strategies cloning works well on paper, it generates market beating returns. Just buy what Buffett buys and sell what he sells and you'll do well the story goes. The problem is when we buy something on someone else's thesis it's hard to hold through thick and thin. If bad news starts to come out on a cloned investment it's easy to dump it and say "maybe this is one the guru messed up on."

Closely related is when investors purchase stocks on a story basis. That is they feel a given company will benefit from some larger trend at some point in the future. Many times when these story stocks are purchased investors aren't conducting true due diligence to see if the company will actually benefit from the trend.

Story stocks are a favorite of the news shows. There's a very specific reason for this. There are two types of stocks, stocks that are great stories, and stocks that are great investments. As someone who writes about stocks I can say that some of my best investments have been my worst posts. This is because there was nothing exciting to write about. There was no narrative or story around the stock. It was cheap, and all an investor needed to do was purchase and wait. Some of my best and entertaining posts have been about stocks that aren't necessarily great investments. But they make great stories. This is the same with the financial media. Companies that make great stories aren't usually great investments.

When we look in the mirror we're facing the enemy of our returns. The best course of action is to pick a strategy, stick to it and move on.

Mod Note (Andy): #TBT Throwback Thursday - this was originally posted on 6/11/15. To see all of our top content from the past, click here.

 

"Most" people fail because investing is a zero sum game. There are two sides to each transaction and only one eventual price for the security.

Add in the potentially non-investable ideal universe of each theoretical index (each has its own problems which can include too many securities to match, no transaction costs assumed, no tax assumptions, liquidity of positions, etc) and it is a zero sum game with the net ending somewhere below the index returns for each market. Then you add in active or passive fees.

"If in theory all one needs to do is follow a few simple formulas, or invest in a few ETF's why aren't more investors matching or beating the market?"

Because you don't buy an index to match or beat the market. You buy it to trail by a few bps in market with high liquidity like the S&P 500 or to trail within a broader range on a market with those investability issues (like in emerging markets).

A better topic would be "why do some investors fail miserably". There's gotta be some fat tails on the retail market return distribution.

 
modestlocke9:

""Most" people fail because investing is a zero sum game. There are two sides to each transaction and only one eventual price for the security." - Trading is a Zero Sum Game but Investing is definitly not.

You're right, and I like this write-up, I just didn't like the comparison about passive investing to match or beat the markets. Have to deal with too many clients who don't understand why investing isn't free.

 
modestlocke9:

""Most" people fail because investing is a zero sum game. There are two sides to each transaction and only one eventual price for the security." - Trading is a Zero Sum Game but Investing is definitly not.

Trading is actually a negative sum game due to brokerage fees. The same could be said for the vast majority of investment funds that churn their portfolios.

 

First - what's the definition of failure and success? My definition of success might be matching the S&P, yours might be matching 75% of the S&P with half the volatility, or beating inflation by 200 bps. Anyone (and this goes for life in particular) has to define their idea of success and failure and this can and probably will change over time (or often).

Second - what game are people trying to play? Short term? Long Term? Infinite? For instance, most retail folks will never have the research, facilities, staff, budget etc of mutual funds/hedge funds etc. So you are probably not going to beat them (in most cases) with any information edge, human resources, systems or constant trading (don't ignore the benefits of lower commissions and tax friendly structures). There are only 24 hours in a day, and you're only one person, right?

My personal thoughts on investing...

OK, how are you going to " successful" or beat managers? Well, you can play your own game with your own definitions. As an individual, you don't have to hire all kinds of people ($$$ and headaches) or have constant redemption pressure from investors (who pull out when market is down, not up, making you sell at even more losses). You don't have pressure from investors to invest NO MATTER WHAT. Funds complain all the time (I've seen this on the illiquid and liquid side) that things are expensive and there is nothing to buy at a decent valuation but that they are forced to invest/trade. WHY? Because clients hate paying fees on money that is not being put to work. As an individual, you aren't receiving fees and don't have client pressure. So you can sit out bubble markets and if you are brave enough, wait for stuff to fall. Psychologically that might be a whole different challenge (when experts are predicting the end of the world etc). But let's not get into that.

Going against the herd, or not with it, is incredibly hard. Most of us are raised to conform from the time we're born...

I used to do Asia-Pacific PE (kind of like FoF). Now I do something else but happy to try and answer questions on that stuff.
 

Investing is the main term of the business and other firms. Most people fail because investing is zero for some fields and cannot achieve more profit in business than in this conditions investors are failing. firms should about know investors what is right and what is wrong.

 
Best Response

They fail because the market accumulates and incorporates knowledge at a faster pace than any individual investor with the exception of those that have inside, i.e., illegal information. In other words, markets are efficient and here's another study supporting this proposition.

EDIT:

95% of finance is bullshit. It tries to convince investors that markets frequently misprice assets and that these champions of the universe (at an extremely high price, of course) can make you very wealthy with little-to-no effort on your end. Empirical study after empirical study shows that your best bet is to put your money into a portfolio of ETFs and focus your effort on other, more productive endeavors.

“Elections are a futures market for stolen property”
 
Esuric:

They fail because the market accumulates and incorporates knowledge at a faster pace than any individual investor with the exception of those that have inside, i.e., illegal information. In other words, markets are efficient and here's another study supporting this proposition.

EDIT:

95% of finance is bullshit. It tries to convince investors that markets frequently misprice assets and that these champions of the universe (at an extremely high price, of course) can make you very wealthy with little-to-no effort on your end. Empirical study after empirical study shows that your best bet is to put your money into a portfolio of ETFs and focus your effort on other, more productive endeavors.

Actually they fail because most people are stupid and don't know what they are doing.

95% of finance IS bullshit, for example volatility does NOT equal risk. Or better still, the efficient market hypothesis that you espouse, which is complete trash, but hey at least the math is pretty!

 

lol if volatility isnt risk, then what the fuck is risk lmao

You know you've been working too hard when you stop dreaming about bottles of champagne and hordes of naked women, and start dreaming about conditional formatting and circular references.
 

read David Dreman, he does regressions on this and finds that using as-reported earnings, the 2nd cheapest quintile of P/E, P/CF, and P/B stocks always outperforms the indices. his data go back to the 60s or 70s, can't remember, but it's pretty solid. the interesting thing is that it's not the cheapest of the cheap, it's the 2nd cheapest. he also tested dividend yield, but this was the weakest indicator. P/E was the strongest, PB not far behind.

also I completely disagree with the "doing too many things at once" (not with you Macro, OP). you need to be diversified, period. guys like you are like Ken Fisher, you recommend 100% US stocks for any type of investor, regardless of their comfort level, and one of 2 things will happen: they will bail out at the worst possible second because they can't stomach corrections, or they will never have a good night's sleep. no matter how irrational you think this is, this is how people are.

 

Agree with this. The only caveat, IMO is that so many retail investors over diversify. ie; with a little research and patience, you can create a portfolio of about 20 stocks with a pretty similar beta profile as a portfolio of 40 or 50 stocks. It kills me to see retail investors who hold 30-40 large caps because they will almost exclusively see beta returns while spending far more time managing their portfolio than if they just diversified with 6 or 7 ETFs.

I've gotten shit on here before for supporting the concentrated position approach, but to me, it just isn't worth the effort to hold more than 15 positions or so. If someone is so concerned about risk, they need to either hire an advisor or buy ETFs/MFs.

"Strength does not come from physical capacity. It comes from an indomitable will."
 

The vast majority of 'smart beta' strategies that are well-known may have worked in the past but aren't likely to work in the future. Very little of the actual capital in the markets is owned by 'retail' investors whose 'psychological biases' allow for marginal investor to reap real returns. Plenty or smart equity stat-arb researchers make consistent returns because they're good at what they do, but any lessons you draw from non-algorithmic trading or simple linear regressions are either biased on prone to data-mining/confirmation biases.

Also, investing is a zero-sum game from a returns perspective, but not from a risk perspective. So like, in a world where no one makes informed decisions and mispricings are frequent and random and randomly 'corrected', long-run index returns might be the same but for non-infinite horizons risk is much higher. Actually, this is false because while stocks are mispriced firms get financed at 'incorrect' prices and markets aren't efficient, so economy suffers. Point is, we are all better off when everyone is 'trying' to beat the markets and in doing so makes it efficient, even if for the many of the individuals involved in the effort the effort isn't worth the (in many cases on balance negative in expectation) reward.

 

Great post.

Just one thing about: : "outside investors are always at a significant informational disadvantage to almost any company insider, even the lowest level employees at times"

Trust me, company insiders from low to mid management level know nothing about their company, I work in a multinational - 10B mkt cap - 40k employees+ and I can bet my net worth than 30 out of the 40 cant explain the company's business and the numbers behind it, who are the competitors, what disruptions are coming from tech or other industries to the company's business, how much assets, revenue & liablities the company runs.

Average people just collect the paycheck and hate their jobs & who they work for and want to know nothing more than what's related to their deliverables.

While this forum is full of ambitious people, average people are a lot different.

Please note: By average people I am referring to lazy, not ambitious people who lack drive, That is literally all you need to succeed.

 

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