Why most Investors are mostly wrong most of the Time!
Marc Faber

In the course of my life as an"investment man" I have repeatedly wondered why investors do not make more money and, in fact, are repeatedly taken to the cleaners by adverse movements in the markets. But before going into details let us put all investments in the right perspective by assuming that someone would have put just one single dollar (or the equivalent) on deposit in the year 1,000. With a compound interest of 5% per annum, this tiny sum of only a single US dollar would have increased by now to US$ 1,546 quintillions (one quintillion equals one million trillions). This sum, invested, today, at just 6% would provide a"modest" annual return of US$ 93 quintillion, which would be about 4 million times larger than current world GDP of around US$ 25 trillion! What I am driving at, is the question as to why the world is not much richer and why even the modest compounding return of just 5%, is in the long term totally unrealistic. Obviously, wealth is repeatedly destroyed by natural disasters such as earthquakes, floods, droughts, plagues, fire, volcanic eruptions, tornadoes etc, as well as through wars, expropriations, high taxes, hyperinflation, depressions, product obsolescence, poor management of companies, etc. But, in my opinion, human investment mistakes or"investment follies" contributed, aside from all these disasters, even more to reduce the world's wealth accumulation to only a very small rate of growth over the long run. In fact, as an investment advisor, it has been my observation that most investors lose money from their investments because they take most of the time the wrong investment decisions at the wrong time. Therefore, most investors would have done better in the course of their lives had they just invested at a fixed rate of interest of around 6% per annum, since at this rate, their money would have doubled in value about every 10 years ($ 1 grows to around $ 1000 in 100 years). But why are most investors performing so poorly, considering that most of them are quite well educated and are running businesses themselves?

I think there are several causes for the poor performance of investors as well as for corporations. First of all, most people, including fortune-tellers, investors, politicians, army generals and company executives grossly over-estimate their ability to forecast the future. Just about a year ago, almost every strategists, economists and analyst was widely positive about the global economy and the high tech and telecommunication sector. But what has happened? The demand for high tech and telecommunication products did unexpectedly slow down while at the same time new capacities came on stream and depressed product prices. Thus, instead of US corporate earnings to increase this year, as expected by all these"intelligent" analysts and strategists, they are going to be down by about 40%. The same happened in Hong Kong. 18 months ago, Internet stocks were red hot, and investors listened to little Richard about the huge future earnings potential of PCCW. And what happened? All the big talk about earnings has by now been replaced with discussions about how long losses will continue. I could go on with countless examples about how even experts totally misjudged the future and how investors were repeatedly caught totally ill footed, when expectations were not met. Therefore, I suggest that a serious investor must start out with the knowledge that he really does not know what will happen in five minutes, let alone one year. The future is simply unpredictable. Otherwise, how would you explain that 85% of all fund managers under-perform the stock indexes. Naturally, every year there will be some forecasters and investors who can claim to have been right. But the problem is that every year there will be different forecasters and investors who will have been right in their projections. Therefore, to simply follow the advise of the advisor who correctly forecasted events last year will in no way guarantee any success the following year.

Then, I have observed a bizarre pattern among people who buy stocks. When some one buys a dishwasher, car, TV set, or PC, he will inform himself first, as to the merits of the different products, which are available in the market. He will check all the advantages and disadvantages of each model and find out where he can purchase the selected model at the lowest price. Moreover, he will frequently wait until a department store has its summer or clearance sales during which prices will be marked down considerably.

But when it comes to buying shares, investors frequently just act on a tip they received at a cocktail party, at 2 o'clock in the morning in a nightclub or from a broker who calls them up. Very frequently investors will not even know exactly what a company does and from what its future prospects will depend upon. At times, they will not even bother to know the name of the company, but just inquire about its symbol or"number" under which it trades on the exchange for placing a buy order as soon as possible! In addition, investors will tend to buy stocks after they have already risen in price, while they will stand aside from the market when prices have declined substantially. In other words, whereas people tend to act"rationally" when they buy goods and services, they act mostly"irrationally" when they invest their money. At markets' top and when markets are over-heated they buy for fear of missing to make a killing, while at market lows, they feel insecure, panic and sell at the worst possible time. Thus, instead of buying low and selling high, the pattern among most investors is to buy high and sell low. This is very evident from the fact that near market peaks, the volume is always very high, whereas at major market lows, the volume is light.

The third feature about investors' behavior, which has always surprised me, is the following. People watch on TV, Michael Schumacher, Andre Agassi, and Mike Tyson. But nobody in his right mind would try to drive at the speed of Michael Schumacher, play Tennis like Andre Agassi or enter the ring for a fight with Mike Tyson. Most people will know that they do not have the skills of these sport stars. Therefore, in view of their limited skills, they will be more cautious and play any sport within their abilities (except the Japanese who ski like Kamikaze pilots). However, when it comes to investing, they read about investment superstars, such as George Soros and then they think that they can invest and take the same risks as these skillful professional investors. In fact, I would argue that investing is very much like the game of tennis in the sense that it is a"loser's game." Only the very best players in tennis can play an aggressive game and"score" points, as a result of their superior skills and precise strokes. The average player, however, loses the game if he plays an aggressive game, because he will himself make far too many mistakes. Thus, the best strategy for an average tennis player is to avoid making many"unforced" mistakes by playing a rather conservative game. The same applies to investments. The best investors may be able to score by being aggressive, but the average investor ought to avoid costly mistakes by being cautious and, in absence of knowing anything about the future, by diversifying his investments. I think this last point is important to understand. No matter how optimistic you are about a particular investment, say real estate, stocks, bonds, commodities and so on, you should always remember that the market could not care less about your views and convictions, but will do exactly as it pleases. Thus, my advice is to always maintain some degree of diversification when structuring an investment portfolio. This diversification would in particular also include investments you really do not like or believe in. Let us assume you were very positive about property shares and very negative about gold. A sensible diversification would, in my opinion, also include the asset you hate the most, since your bullish view about property shares might be as wrong as your bearish view about gold! The same would apply to currencies. No matter how positive you might be about the US dollar, you should at all times maintain some exposure to foreign currencies such as the Euro.

Another feature about investors, which has repeatedly puzzled me, is how investors - who I have never met before - constantly come to me - often at 4 o'clock in the morning when they are drunk and I, myself, sometime even more so, and ask me,"what do you currently recommend?" To ask any investment advisor what he currently recommends is the same as approaching a medical doctor and asking him what kind of pill he currently recommends. Obviously, what pill a physician recommends will depend on the illness of the patient and a doctor will never recommend a"universal" pill, which can cure every single disease. Similarly, a serious investment advisor would have to know everything about your current assets and liabilities before making recommendations. Just consider that if you already had 95% of your assets in real estate and you were highly leveraged, the advice to purchase real estate stocks would not make much sense. Conversely, for the person who holds only cash deposits, such a recommendation might be appropriate. Thus, my advice for investors is not to ask anyone what he recommends - this certainly not in the middle of the night in a bar - but to sit down with an advisor and have a serious discussion with him about your financial condition and then see what he might advise you to do. I also recommend paying a fee for such advice, because I have the view that"good and independent advice" never comes free.

Finally, I have found that investors tend to be totally wrong at major turning points. From the late 1960s to 1980, gold and silver rose very strongly. By the late 1970s, everybody around the world was trading gold 24 hours a day and had become convinced that gold would continue to rise forever. But, after 1980 gold fell and stocks and bonds began their persistent bull market until last year. By then, the mantra was that stocks would rise indefinitely and that one had to own the"new economy" stocks. Now, however, we know what happened to all these new economy stocks. What seems to be the pattern in the world of investments, is that the longer a trend has been in place, the more convinced investors become that the trend will last forever and that nothing can interrupt or permanently reverse such a trend. Yet, history suggests differently. Just think about the most popular stocks of the 1980s - the forever rising Japanese shares. They are today, more than 11 years after the 1989 peak still down 70%. The same is true of the Taiwan stock market. Thus, the longer a bull market lasts and the stronger this bull market rises, the more cautious and skeptical an investor should become about its sustainability and durability, which is, however, exactly the opposite of what investors do in real life.

How the world will look in twelve months, I do not know. Stocks are, today, much better values than a year ago, but it seems to me that corporate earnings will remain under pressure in the US and that, therefore, after a rebound rally, more pain might be in store. Moreover, I believe that the great US stock bull market, which began in August 1982 came to an end between 1999 and 2000 and that from here on, the US market may just trade in a range or continue to decline for several years. In general, equities in countries like Indonesia, the Philippines, Malaysia and Thailand are very inexpensive and, since they are down by about 80% from their highs, they appear to offer better value than US stocks. Even in Hong Kong, there are now stocks, which are reasonably valued. An asset, which is very inexpensive compared to equities, is gold, and, as I mentioned above, some diversification into assets nobody likes does make sense. After all, the strongest bull markets always emerge from the sectors, which are the most unpopular and do not attract any attention by the investing public.

Marc Faber, 2001

<ul> ~ Marc Faber: gloomboomdoom-report</ul>
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