Research shows that unlike investing professionals, they can afford to stay cool in the face of panic-inducing events
Fear of the Wuhan coronavirus, also known as COVID-19, has caused chaos in financial markets around the world; Canada hasn’t been immune, as the panic has wiped out year-to-date gains in the S&P/TSX Composite as of yesterday.
Canadian small investors can’t be blamed for wanting to sell their stakes in the market under these conditions. However, if they can keep their composure and hold fast, they may be able to do well for themselves — and possibly even beat the pros.
“Professional investors tend to move the fastest when a market suddenly turns … because the biggest risk they face is being so out-of-step with the market that their clients fire them,” Wall Street Journal columnist Jason Zweig noted. “That can lead the pros to chase the market trend too far and too long.”
Zweig cited a 2002 study by finance professors Patrick Dennis and Deon Strickland, which found that institutions sell more than small investors during large stock-market drops. The stocks they drop, he added, tend to see market-beating returns over the following six months.
Unlike asset managers who are beholden to unitholders and asset owners, individual investors aren’t under any pressure to attract funds or maximize fees. That means they can afford to make unorthodox investment calls, including waiting for institutions to unload their most-liquid holdings and snatching them up at more attractive prices.
Zweig also pointed to the results of research from Vanguard, which pointed to individual investors’ role as “a major force for moderation in the financial markets.” In a newly released survey of — the latest in a bi-monthly series that started in 2017 — the firm found that American individual investors expect U.S. stocks to return about 5% over the coming year, compared to the historical average of 10% annually, which counts dividends.
“Among those individuals, nearly 60% forecast one-year returns between 0% and 6%, and just under 70% predict 10-year average annual returns in that same range,” Zweig said, adding that professional investors frequently forecast annual returns exceeding 7.5%.
Individual investors were also found to make lower predictions following a stumble in the stock markets, and to revise upward when stocks do well. But in both instances, they don’t adjust their forecasts by much. Following market volatility in 2018 that led to 20% fall in stocks from September through December that year, Vanguard investors dialed down their expectations from 4.8% to 2.7%; by February 2019, during the subsequent recovery, investors projected stocks would earn 4.9% over the next 12 months.
