Five reasons you are better than a fund manager

26 May 2020

Who says that you can’t beat the investment professionals? We look at the skills you have without even knowing it

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Even if you have never invested before, the chances are you could be very good at it. Don’t believe me? That may be even greater proof that you would excel.

Investing can seem like an intimidating business, encrusted as it is with jargon and bloated with experts and professionals making a fortune from it. But there is no reason to be put off: a nimble beginner investor even has some advantages over the professionals.

1 A lack of confidence can work in your favour

Sometimes the best investing strategy is to sit tight and see what happens. After all, it is very hard to predict how markets will fluctuate in the short term and investing is for the long term.

Doing nothing and not reacting to market movements can be much easier if you are not overly confident – a lack of conviction that you know which way markets will go next or how to respond can lead to inertia.

As our confidence grows, it gets harder not to meddle. We start to think that we know better than others and so we start to change our portfolios based on our predictions – whether they are right or not. And making quick changes will be unlikely to produce a good outcome on balance.

Jessica Exton, behavioural scientist at banking and financial services firm ING, says: “We naturally tend to be overconfident in our abilities, which can result in making frequent changes to our investment strategy over time.

“It has also been found to encourage us to take on higher levels of investment risk if we believe we can predict what will happen in the market more accurately than others. Both of these tendencies can lead to lower investment performance in the long run.

“Being overconfident in investing has also been found to increase with investing experience and education. This suggests that those without a lot of experience in the stock market may be less likely to frequently change their strategy and avoid overreacting to short-term market fluctuations.”

A study by professors Barber and Odean at the University of California laid bare the cost of overconfidence leading to overtrading.

James Norton, senior investment planner at Vanguard, explains: “Over a six-year period, professors Barber and Odean carried out detailed research on more than 78,000 US brokerage accounts, analysing over three million trades. Specifically, they wanted to understand how investment returns differed for the 20% of investors who traded the most compared to the 20% who traded the least.  

“The results were truly shocking. The confident, frequent traders achieved returns of 11.4% a year compared to 18.5% a year for the less active traders. To put this into perspective, £1,000 invested at the beginning of the period would have grown to over £2,700 after six years for the active traders, compared to over £4,000 for the infrequent traders. Interestingly, the professors also found that women traded less frequently than men and consequently had better returns.”

2 You can keep it simple — and simple is good

Fund managers need to attract funds and fees with theories, names and performance that make them stand apart. But despite all this, many will not do any better than cheap, passive funds that are not actively managed by fund managers, once fees are factored in.

“As an individual investor, you have the licence to keep it simple,” says Vanguard’s James Norton. “A fund manager needs to get assets for their fund or they don’t have a job.

“It’s human nature that we tend to like things – especially in investing – that sound more complicated and think they will be better.

“Over the years there have been trends for particular words to appear in the names of funds: ‘alpha’, ‘plus’, ‘special’. They make you feel as if you have found a good fund. But although index or passive funds don’t have jazzy names, their performance tends to beat most actively managed funds.

“You can have a globally diversified portfolio of stocks and bonds in two holdings and for around 0.2% a year.”

3 You are investing for the long term

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Individuals invest for future goals; for retirement, or for a deposit for a home, or to gain financial independence. With long-term horizons of at least five years and often of decades, we can afford to ride out the highs and the lows of the stock market. A spell of losses is not the end of the world when you have sufficient time for your portfolio to recover.

While most fund managers would say they, too, invest for the long term, in reality many will come under pressure if they have periods of poor performance. Thinking practically, a fund manager will not attract new investment and may see investors withdraw their funds if it stops making money for its investors.

A fund manager may have a benchmark or target that they are tasked with outperforming; they may be under pressure to attract new funds by coming up with an interesting sounding proposition; or to show good performance every quarter which can curb their ability to think long term.

This pressure may force professionals to make changes or to act in an attempt to improve short-term performance, missing out on the opportunity to invest in a way that will harvest rewards longer term.

After all, some companies may take time to grow and start producing good profits – as investors in these, sometimes you need to play the long game.

Lee Wild, head of equity strategy at interactive investor (Moneywise’s parent company), says: “As an individual, if your investments’ return is, say, 5% above inflation, you may be happy with this outcome. If you are a professional, 5% above inflation does not look like such a good outcome if your benchmark has returned 6%.”

4 You don’t have to worry about tax

As a beginner investor, it is unlikely you will have to worry about filing tax returns, keeping track of capital gains tax and messing around with endless paperwork.

If you invest in a Stocks and Shares Isa, there is no tax to pay on any gains that you make while you are investing or when you come to spend them. You can invest up to £20,000 each year in a Stocks and Shares Isa and don’t have to fill in a tax return or alert HMRC.

Later on, should you start to breach this amount, there may be tax implications and reliefs to be aware of, which makes things trickier. However, using just your full Isa allowance alone could make you an Isa millionaire in just 17 years, assuming average returns of 5% a year.

5 You are likely to be more open-minded

Diving into the theories and technicalities of investing can be useful and, of course, it is good to understand what you are investing in. However, there is an argument that this could lead to more narrow thinking if you are not careful.

James Anderson, manager of Scottish Mortgage Investment Trust, believes that investors need to hear a variety of views, and yet this is often not what professionals do.

Investing professionals tend to study for the same qualifications, learn the same theories and read the same materials, which can lead to an overdependence on certain ideas.

For Anderson, it is the Chartered Financial Analyst program that distorts views in particular, with its attachment to value investing – buying shares in companies that look cheap.

He says: “We don’t take the view that individual investors are worse than institutional ones. I find, by and large, individual investors are both much more open to different approaches and much more long term than the bulk of our institutional clients.”

So put your lack of confidence to good use – and show the professionals how it is done.

This feature also appeared in the Mail On Sunday.

First published on 27 May 2020

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