Kim Snider
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September 14, 2005

Investment Return Doesn't Mean Diddly

It was one of those "Aha!" moments. I had a total revelation yesterday about what business I am in.

 

Now you would think, having been in the same business for years now, I would know what business I am in. But I didn't - and it just dawned on me.

 

If you asked me a week ago what my company did, I would have told you we teach a proprietary investment methodology that has averaged a very consistent 13% yield, paid out monthly, with about the same risk as an investment grade bond portfolio, and that only requires a few hours once a month to keep up with. I would have told you that we teach our investment method in two day workshops. And everything I just told you is true.

 

But that explanation of what I do would probably lead you to believe that I am, first and foremost, in the investment business. But I am not. I just did what so many of us do, which is to minimize the most important aspect of investing - our behavior.

 

We (advisors, fund companies, academia, the financial press and even investors themselves) tend to focus on investment return. That is the return that one would get by making an investment, going into a coma for some period of years, waking up, and then seeing what your investments had done while you were snoozing. That is the actual return of an investment. In the case of the Snider Investment Method that has been a very consistent 13%.

 

But chances are you aren't getting anywhere near the investment return so whatever that number is, it is irrelevant! There is a big difference between investment return and investor return. Why? Because most of us don't fall into a coma for thirty years. We are human. And because we are human, we take actions and those actions have consequences - almost always negative.

 

DalbarTake a look at the Dalbar results, a study I have been talking about incessantly for at least five years now. Dalbar looks at the results of investments and investors as compared to the market.

 

You can see that over the 19 year period 1984 to 2002, the S&P 500 was up an average of 12.9%. U.S. stock mutual funds had a return over the same period of only 9.6%. That is the investment return of U.S. equity mutual funds. But the stock mutual fund investor had a return of only 2.7%! That is the investor return and I think we can all agree that is a very meaningful gap.

 

Q. What causes these gaps? A. Human nature.

 

We are all human and, as such, our decision making processes are badly distorted by biases and emotions. Financial behaviorists have identified any number of emotional biases which measurably affect our investment decision-making.

 

(For a great introduction to behavioral finance, I suggest reading either Investment Madness by John Nofsinger or Mean Markets and Lizard brains by Terry Burnham, both of which can be found on my Recommended Reading List.)

 

Our emotional biases, such as familiarity bias, representativeness bias, and expert bias, cause us to overestimate our level of knowledge, underestimate risk and exaggerate our ability to control events. It is these biases that cause us to believe that we can outsmart the market by picking stocks that will perform better than the market as a whole or time the market's ups and downs.

 

The negative effect of our biases can be seen in the gap between the market's performance and the return generated by the fund managers. If anyone should be able to pick outperforming stocks or time the market it should be these guys. But their actual results tell the real story. Rather than resulting in a positive variance to the market, their attempts actually underperformed the market by 3.3%.

 

The difference between the investment performance and actual investor performance is even bigger. This gap is caused by our emotions - our reactions to fear and greed which cause us to do the opposite of what we should be doing. Fear and greed cause us to buy when we should be selling and sell when we should be buying resulting in our uncanny knack for buying at tops and selling and bottoms. This response results in investor performance over a period in which the market made unprecedented gains of only 2.7%!

 

The low hanging fruit here would seem to be fairly obvious. We can apply the Pareto Principle - 20% of the effort can get us 80% of the results. The quickest way to improve actual performance for actual people trying to save for an actual retirement is not to focus so much on what they are investing in but instead to focus on modifying their behavior. If all we do is close that behavioral gap, we can improve your performance by 350%!

 

To close the remainder of the gap, we have to change what you are investing in. We have to stop you from gambling on stocks because you will never outsmart the market. Instead, we want to bet against the fools who continue to bet on stocks. In other words, we want to bet with the house.

 

The Snider Method does both of these things. The epiphany is that I tend to talk mostly about the smaller piece, which is not betting on stocks, not trying to outsmart the market. We give little or no emphasis to the incredibly detailed, probability-based methodology we have created to keep ourselves from reacting in a biased or emotional way.

 

So the change in my thinking is this - the Snider Method is not as much a method of investing but rather a method to systematically modify your investment behavior. If I can get you to do just that, nothing else, you will have accomplished a major step toward financial freedom. And that is what it is all about to me - helping people build lives full of love, joy and abundance.

 

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

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Focus of This Blog

Kim Snider is an author, speaker and host of Financial Success Coaching, Saturdays at noon, on KRLD Newsradio 1080, Dallas - Fort Worth. This blog is primarily devoted to empowering individual investors with information to help them be good stewards of their money. Above all, it is about achieving true financial success. Kim's book, How To Be the Family CFO: Four Simple Steps to Put Your Financial House in Order is in bookstores now. Order yours from Amazon or other fine booksellers today.

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