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June 3, 2011 6:57 pm

Emotion and personality determine investment returns

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One in three private investors believes frequent trading is the key to investment success – even though “emotional” overtrading has cost investors nearly 20 per cent in returns over a 10-year period – a new study has revealed.

For its report into “Risk and Rules: The Role of Control in Financial Decision Making”, Barclays Wealth surveyed more than 2,000 investors in 20 countries who each had more than £1m in investable assets – and found that behavioural biases dramatically affected their portfolios’ performance.

An analysis of their trading habits showed that a lack of self-control resulted in a “trading paradox”: one-third of those polled (32 per cent) said that trading frequently was necessary to generate a high return, but those respondents were more than three times more likely to feel that they traded too much. When asked what compelled them to trade so often, almost half (46 per cent) said “emotion” forced them to do it.

However, research into private investors’ returns, commissioned by Barclays Wealth from the Cass Business School, suggests that this behaviour loses money. From 1992 to 2009, the average annual return from UK equity funds was 6.5 per cent, but the average private investor made only 5.3 per cent. From this, Barclays Wealth concludes that poorly controlled trading has cost investors nearly 20 per cent of the available returns over a 10-year period.

Even so, investors appear keen to overcome these inbuilt flaws. A third (33 per cent) of wealthy UK investors told Barclays they wanted more financial self-control – and the desire for trading discipline was felt most by those at the wealthiest end of the scale (those with assets of £10m+), where 45 per cent of respondents wished to change their behaviour.

Those who already employ investing rules find them to be effective. Investors with the highest strategy usage in the survey enjoyed 13 per cent more financial satisfaction and 12 per cent more wealth than those who did not use rules. Popular strategies included waiting before executing a financial decision and setting deadlines.

“If we attempt to follow a fully ‘rational’ path without self-control, the effects are clear: we will overtrade, and we will buy high and sell low,” explains Greg Davies, head of behavioural finance at Barclays Wealth. “To prevent this, we need to exert self-control. This can only happen if we give something up, such as our flexibility to respond to market movements with knee-jerk reactions.”

In the current climate, though, UK traders are finding this difficult to do. “We have seen the trading activity of those customers who regularly place in excess of 31 trades per quarter increase by around 42 per cent year on year,” says Darren Hepworth, trading and customer services director at TD Waterhouse, the stockbroker. Ben Yearsley, of advisers Hargreaves Lansdown, also believes clients have become more short-termist and partly attributes it to “volatility in the markets, as companies tend to get punished or rewarded very quickly”.

But Guy Knight, director at The Share Centre, the stockbroker, says the longer-term trend is to less frequent trading. “During Q1 2011, we saw a 4.63 per cent increase in trades compared with the previous quarter and a 16.4 per cent increase from the same period last year. However, this is due to an increase in people turning to investing to generate better returns on their cash, rather than an increase in the frequency of customer trades. According to research by Compeer, execution-only brokers are actually seeing a decrease in the number of trades per account.”

Compeer’s figures show that the number of trades per broking account stood at 1.24 in Q4 2009, falling to 1.06 in Q4 2010 and then to 0.97 in Q1 2011. “Contrary to the claims of overtrading, private investors have a tendency to fall in love with their investments and consequently may hold on to them for longer than they should,” Knight argues.

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