The markets have this uncanny habit of making investors believe in their own superior investing skills during a bull phase. I’m reminded of the quote – ‘A rising tide lifts all boats’. In the present context, it means that almost everybody makes money in bull markets, irrespective of whether their stock, or even fund picks are good or not.
The after effect of this over-confidence is that investors start chasing unrealistic rates of return on their investments. For example, an investor who started investing in 2004 would have seen returns of 40 per cent, 44 per cent and 45 per cent in the next three years. These are exceptionally high rates of returns by any standards. Even the great Warren Buffett couldn’t manage returns of 30 per cent plus in his career.
So, if this investor now expects to earn more than 40 per cent every year till eternity, then that is not going to happen. These rates are not sustainable. In 2008, such an investor would have been shocked to see a drop of more than 50 per cent in share prices.
This is the biggest problem with investors. They have very high expectations from the markets. They want markets to double their money overnight (read: in a very short period of time). This makes them chase unrealistic rates of return on their investments. Consequently, they end up taking risky bets and losing money. End of story.
Most of the time, this happens due to a lack of awareness about historical returns, and more importantly, due to a lack of rational thinking on the investors’ part.
For a moment, let’s ignore the after-effects of bull markets, and focus on bear markets. After a sustained bear market, it becomes difficult for investors to remember that investments can actually produce high positive returns. This is exactly what happened when the markets gave zero returns in five years – from the peak of 2008, to the reclamation of the same peak in 2013. Investors were caught unaware and had low expectations from the markets. We all know what happened after that. The markets shot up and have been making new lifetime highs every now and then.
Historically, good funds in India have been able to deliver returns in the excess of 15 per cent for almost a decade. Some have even managed this for over 15 years! But if we are expecting our investments to deliver more than 25 per cent every year for the next 20 years, and that too just because last year we made close to 30 per cent, then we are guilty of chasing unreasonable returns.
Chasing 25 per cent returns every year requires that more risks are taken. So, the more risk we take, the higher would be our chances of earning high returns. However, unfortunately, at higher risk levels, it is lower returns that become more achievable. Hence logically, we are better off toning down our expectations to reasonable levels.
In an interview, noted billionaire investor, Howard Marks, said that in investing, “the most important thing is to have reasonable expectations. And that’s a pretty good rule for life too”. Sounds so wise and true, doesn’t it?
As an investor, our goal should be to have realistic performance expectations, and to build a portfolio of funds and stocks that consistently delivers performance that is reasonably close to those rational expectation levels. If we are able to achieve this simple thing, we as investors will be secure, moving consistently towards our financial goals, and more importantly, we’ll be at peace with regard to our investments.