If you're superstitious, here's the best way to invest
[Estimated time to read: 4.5 minutes]
Passive investing is all about putting trust in independent, peer-reviewed and time-tested evidence.
However, many active investors – like the fund managers who look after most people’s pensions – prefer to rely on hunches and opinions, and some are just downright superstitious.
In 2014, three academics looked at the cost of superstitious behaviour.
They focused on the Taiwanese stock market.
In Chinese, the number 8 sounds like the word for prosperity, and the number 4 is similar to the word for death.
The researchers measured the strength of traders’ superstitions by the regularity with which they chose prices ending in 8, and how keen they were to avoid the number 4.
The financial cost of superstition
The researchers discovered that investors were over 50% more likely to place an order ending in an 8 than a 4!
As a result, the daily returns of the most superstitious quintile of investors were 0.03% lower than the least superstitious.
That equates to an annual shortfall of a staggering 8.8% a year – what impact would that have on your pension?
More recent research, by David Hirshleifer at the University of California, Irvine, and Ming Jian and Huai Zhang from Nanyang Technological University in Singapore, identified similar patterns.
Their focus was on Chinese IPOs, and the extent to which investors chose or avoided different offerings depending on their listing code.
“In summary,” their paper concluded, “our findings are consistent with market prices being biased by superstitious beliefs about lucky numbers.”
It’s not just Asian investors
Many Asian cultures are fairly superstitious, but investors in the West can be equally irrational when it comes to superstitions and beliefs.
There are, in fact, all sorts of superstitions surrounding investing, all of which could be having a disastrous effect on your pension fund…
The October effect
Many of the biggest stock market crashes have happened in October, most famously in 1929.
Black Monday in 1987, and the Asian currency crisis 10 years later, also both happened in October.
So did the collapse of Lehman Brothers, the event that triggered the global financial crash in 2008.
However, when you look back through market history you’ll see that on average, October hasn’t been a particularly bad month for stocks at all.
But this doesn’t stop the media talking about the October effect…neither does it prevent investors and fund managers from acting on it, every year.
Sell in May and go away
Another superstitious theory that many investors follow is that they are better off keeping out of equities over the summer months.
The Santa rally
This is the perception among investors that stock prices tend to rise in the run-up to Christmas.
Truth or fiction?
In some of the above cases there may be a tiny element of truth, but distinguishing genuine patterns from pure random chance is impossible. As is acting on these beliefs and actually profiting from them!
If you, as an individual investor, decide to sell stocks in May, only to find that stock markets rise over the summer months, what do you do?
You’re left with the dilemma of when (or whether) to get back in to the market…and as a regular reader of our blogs, you’ll know that trying to time the market is dangerous.
Sillier superstitions still…
Sell in May and the Santa rally at least sound plausible, but there are plenty of other market indicators that are far more ridiculous.
In the 1970s a sportswriter named Leonard Koppett observed that if a team from the American Football Conference won gridiron’s most coveted prize, then a bear market usually followed. But, if a team from the National Football Conference came out on top, stocks would go on a bull run.
This observation was supposed to be a bit of fun…but the Super Bowl Indicator, as it has become known, has taken on a life if its own in recent years!
It has actually proven remarkably reliable - since 2000 the indicator has been right 12 out of 17 years — that’s a success rate of 70%.
As this year’s Super Bowl winners, the New England Patriots, are an American Football Conference outfit, the theory goes we should now expect stocks to end the year lower.
The Super Bowl winner isn’t the only wacky market indicator that pundits like to talk about. There are, for example, indicators based on the height of ladies’ hemlines, lipstick sales, whether or not Boston has a white Christmas…
Some people even choose to buy stocks when butter production surges in Bangladesh.
As Warren Buffett famously said: “…the only value of stock forecasters is to make fortune-tellers look good…”
Why you are not immune to irrational behaviour
You may be reading this and thinking that none of it applies to you.
But the truth is, every investor, to some degree, is prone to irrational behaviour!
Whether it’s only owning stocks that you’re familiar with, concentrating your equity exposure exclusively in your own home market, or just wanting to justify poor investment decisions that you’ve made in the past…we’re all guilty to some extent.
And, using actively managed funds is itself a form of superstition.
It involves having faith in the view of one individual, or group of individuals, that the market consensus — that is, the combined wisdom of every single market participant — is wrong.
The overwhelming likelihood is that, after costs, the manager looking after your pension will not be able to outperform the relevant benchmark over the long-term.
So stay rational, stick with the evidence, and remember, superstition and successful investing really don’t mix.