Most people turn to the experts when seeking guidance in any number of areas. We go to the doctor when looking for advice on how to treat a health or medical issue, sometimes even seeking a second opinion. We hire a lawyer to help win a lawsuit, or a financial advisor to help us invest. Seeking the guidance of an expert is often the most wise and rational thing you can do. It turns out, however, that in terms of investing your money, you may be the best expert there is.
Investment professionals don’t always have the best ideas. In fact, according to behavioral finance research, these advisors claim to be spot on with their market predictions about 80% of the time, but the truth is that they are only right about 40% of the time. Most investment professionals’ high level of overconfidence, when asked to assess their abilities, is rooted in a belief that they are somehow “special,” or more educated, in terms of analyzing the markets, than the rest of us. That bloated sense of self, however, often leads those experts to make inaccurate stock forecasts.
According to a study entitled The Quantitative Analysis of Investor Behavior Report, put out by Dalbar, Inc., a financial services and market research firm, over the past 30 years, the S&P 500 returned an average of 11.11% annually. By comparison, individual investors only averaged a return of 3.69% over that same period. The numbers don’t lie. As it turns out, just simply investing in the market would have been a better bet than following the advice of an investment advisor or stock market guru. (For related reading, see: Do You Need A Financial Advisor)
Prone To Overthinking
People’s inability to make consistently correct market predictions can be blamed on the fact that we are just not wired to do so. Instead, we hold inherent behavioral biases that lead us to make impulsive and impractical decisions, and to think unrealistically about the future. All told, these biases work to lessen our ability to make wise financial decisions. By contrast, humans do have a knack for making decisions that affect our current situations, such as quickly leaning how to adapt to a new physical environment or social setting.
But when it comes to betting on the market, a degree in finance won’t make up for a person's inherent cognitive difficulties. In fact, one study even suggests that the more educated a person is, the more prone they may be to overthinking, which can lead to bad financial decisions. Being aware of one’s inherent biases doesn’t seem to help any, either, in terms of overcoming them.
Why The Best Financial Advisor Might Be You
Turn to the Data to Make Better Decisions
The best bet for individuals looking to win in the market is to turn to relevant data as a guide. Continually monitoring and evaluating one’s investments and making necessary adjustments as markets change, is also key. Relying on gut instinct, on the other hand, won’t get you very far. Even investment advisors, who profess to have better solutions than the average individual investor, are often simply just making an educated guess. (For related reading, see: 5 Facts Financial Advisors Wish You Knew)
In fact, research by CXO Advisory shows that since 1998, many well-known market predictors including Jim Cramer, Marc Faber and Robert Prechter are correct in their investment forecasts only 46.9% of the time. So individuals looking for sound investment advice may be better served by turning to money managers who rely on data-driven statistical models and who obey formal investment rules that take into consideration a changing marketplace.
Still, not all investment models work all of the time. Sometimes, plain old-fashion good judgment serves as the best guide when making any investment decision. (For related reading, see: How To Get The Most Out Of Your Financial Advisor)
The Bottom Line
Individual investors should consider relying on a data-driven investment process before heeding the advice of investment gurus. They should continually review their investment processes and look for ways to better them. Rather than focusing on results, investors should focus on the method for achieving those results. And lastly, investors should stay mindful of what could go wrong with an investment decision and try to find ways to defend or hedge against pitfalls.