A survey conducted by the Commission for Financial Capability and the FMA, of investors over the age of 50 has found some fascinating behavioural characteristics about investors. In particular how we judge risk and return.

The survey found that virtually all (97%) of people know that level of investment risk should align with a person’s circumstances and goals, however 80% of people think high investment risk is something to avoid and 70% believe ‘most people’ should choose lower risk investments.

Also, perhaps more alarming, the respondents investment return expectations are far too high.

The median response of those surveyed regarding the investment returns they’re currently expecting are:

 

Expected Annual Return

A ‘fairly low’ annual return

5%

A ‘medium’ annual return

9%

A ‘fairly high’ annual return

15%

 

Interestingly, these return expectations are similar to the recent strong performance of KiwiSaver Funds outlined in the June 2015 Morningstar KiwiSaver Quarterly Report:

(Returns are after fees & before tax)

Actual 3-year p.a. return

Avg. of Conservative KiwiSaver Funds

8%

Avg. of Balanced KiwiSaver Funds 

12%

Avg. of Growth KiwiSaver Funds

15%

 

Ironically, the survey seems to suggest that people are risk averse (seeking to avoid risk) and at the same time are expecting very high returns.

Investment returns over the past 3 years have been very high, and according to the survey people are expecting these very high returns to continue. This is alarming but actually quite natural.

It’s known as recency bias, or recency effect.

In other words, people are projecting what’s happened recently (great investment returns) to continue consistently into the future. It’s a natural human cognitive bias that we’re all susceptible to and need to actively fight-off.

To put the respondents return expectations in perspective, a higher risk/higher return investment like NZ shares has returned about 9% p.a. before any fees or tax over the past 20 years.[1]

9% p.a. is well below what investors currently view as a ‘fairly high’ return of 15% p.a. and in-line with what investors currently view as a ‘medium’ annual return.

It would be interesting to know what people thought were ‘low, medium and high’ returns back in 2009 shortly after the Global Financial Crisis. It’s likely their projections of future returns would have been much much lower than they are now.

The survey highlights how important it is for investors to remember that markets are cyclical and not to get caught up in short term trends.

 

Sean Donovan

KiwiSaver Associate

Disclaimer: This blog is intended to provide general information only. It does not take into account your investment needs or personal circumstances and so is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser.

[1] IRESS/Bloomberg. Time period from 31/12/95 – 31/12/14 in local currency. “NZ Shares” refers to the NZ All Ordinaries total return index.