The importance of discipline explained - January 30, 2019

The importance of discipline explained

Individual investors tend to sell their assets low and then reenter the market when prices are high. Some weeks ago, we promised to show you how this emotion-driven behavior can hurt investors. Now the time has come: this post explains the serious consequences of not having discipline and exiting (then reentering) the market at the wrong times.  

Patience and discipline are among the most important skills that an investor can have. Why? Because without these, people can make bad investment decisions, therefore hurt their returns or even face losses.

When is discipline the most needed?

Discipline is always good to have but it becomes super important during market corrections and fluctuations. The reason is that emotions usually don’t help business decisions. As Investopedia puts it: performance of investments was “most affected by the fact that investors were unable to manage their own emotions and moved into funds near market tops while bailing out at market lows”. This is one of the direst errors an investor can make.

S&P 500's rise since Christmas Eve

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These bad decisions can hurt a lot, even on the short run. As we mentioned it last week, people who were motivated by their emotions and sold their stocks during Christmas, already missed out an over 10% soar on the markets. What’s more, if they had sold their assets at low prices back then and started to rebuy them now, they seriously hurt their own interest.

Bad decisions on the medium run

This is a well-known effect, which was proved by Dalbar, a leading business evaluation firm, too. They run extensive researches on investor behavior, named QAIB. Their newest study concluded that in the last 20 years, investors usually abandoned their investment in less than 4 years. This is a problem, since even mid-term investments start at 5-years and portfolios are often optimized for even longer periods of time.

Individual investor's vs. S&P500's returns in 5-year

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But Dalbar had an even more serious takeaway in their study. The performance of a simple stock index outperforms that of the individual investor by far. In a 5-year term, the average individual investor’s return was 10.93% while S&P 500’s was 15.79%. This means that by investing $10 thousand an individual investor makes $6 thousand in 5 years while S&P 500 earns almost double.

Long-term losses are even worse

The difference found by Dalbar becomes even more significant on a 20-year term. It’s $18 thousand against $30 thousand in profits. We have another very interesting example: the financial crisis of 2008. During this time a huge number of investors got scared and sold their shares at low prices after the bankruptcy of Lehman Brothers.

S&P 500's 100%+ rise between 2 September 2008 and 24 January 2019

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If they had the needed discipline and kept on to their stocks instead of selling them and then (as investors often do) rebuying them at higher prices, they could have made a decent return. And we mean very decent return: since the crisis stocks skyrocketed. S&P 500 had an over 100% rise since the beginning of that crisis and reached new record highs.

True, this is a long-term effect, but investors should think in long-terms.

Disclaimer: This analysis is for general information and is not a recommendation to sell or buy any instrument. Since every investment holds some risk, our main business policy is based on diversification to minimize threats and maximize profits. Innovative Securities’ Profit Max has a diversified portfolio, which contains liquid instruments. This way, our clients can maintain liquidity, while achieving their personal investment goals on the long term.