Sam Sivarajan is a keynote speaker, independent wealth management consultant and author of three books on investing and decision-making.
AI-driven stocks such as Nvidia Corp. NVDA-Q have dominated news headlines and sparked a rush among investors hoping to cash in on the next big thing. But as the flow of money into these stocks continues to surge, it’s worth asking: Are investors, especially DIY investors, chasing the hype and getting ahead of themselves?
The answer is likely yes. Goldman Sachs reports that “tech giants are set to spend over US$1-trillion on AI in the coming years, with little to show for it so far.” MIT economist Daron Acemoglu argues that “truly transformative changes will take time, with few expected in the next decade.”
Retail investors often get swept up in market hype, as we saw in the dot-com bubble and cryptocurrency craze. Those who invested at the peak saw their portfolios crash when the bubbles burst. DIY investors are prone to biases such as overconfidence and recency, making impulsive decisions that professional advice could prevent.
And it’s not just novices – sophisticated DIY investors can also fall victim to emotional, biased decisions. As behavioural finance expert Meir Statman has noted, frequent traders underperform dramatically compared with their more patient, buy-and-hold counterparts. Prof. Statman’s research reveals that heavy traders lagged index investors by more than seven percentage points a year, while light traders trailed by just a quarter of a percentage point.
DIY investors can easily fall into the trap of overestimating their abilities. They may believe that access to information (such as trends in AI stocks) equips them to make savvy trades. However, as Prof. Statman’s findings highlight, many end up switching between funds – especially in high-risk, high-reward sectors such as tech – and significantly underperform. For instance, those who jumped between technology funds lost 13 percentage points a year compared with buy-and-hold investors.
Even hedge fund investors, often viewed as highly sophisticated players, are not immune to underperformance. A study by professors of accounting Ilia Dichev and Gwen Yu found investor returns in hedge funds lagged buy-and-hold returns by 3 per cent to 7 per cent a year.
Finance professor Brad Barber’s study of users of investing app Robinhood highlights another DIY investor challenge: attention-driven trading. Robinhood’s trending stocks feature often leads users to chase fads, resulting in losses. The research shows that stocks heavily purchased by Robinhood users tend to have negative returns, on average -4.7 per cent, over the following 20 days.
These patterns are not unique to finance. The phenomenon of overconfidence extends to other fields as well. Doctors sometimes misdiagnose themselves, and a popular saying is that a lawyer who represents themselves has a fool for a client. It’s not that these professionals have lost their skills – they’ve simply lost their objectivity. Just like DIY investors.
Without a dispassionate, external perspective, many investors allow emotions to cloud their decisions. This can lead to impulsive trades driven by fear of missing out or irrational exuberance over the “next big thing.”
Good professional advisers manage clients’ biases and emotions, becoming behavioural coaches rather than stock pickers, helping investors stick to a plan. They can provide a buffer between investors and the psychological traps that can derail their financial goals. Morningstar found that, over the decade ending Dec. 31, 2023, the average investor lagged the average fund by 1.1 per cent a year, missing out on about 15 per cent of the total returns as a result of poor timing of buying and selling. A behavioural gap.
But does that mean investors should surrender all control to professionals? Not necessarily. A more nuanced approach involves co-creating investment strategies. The “IKEA effect,” a psychological principle that suggests people place more value on something they’ve helped create, offers compelling support for this approach. Similarly, a study involving children cooking alongside their parents found that kids ate more salad and vegetables when they helped prepare them.
The same holds true for investing: If investors are actively involved in shaping their financial plans, they’re more likely to stick to them.
This collaborative approach can help investors feel in control, while still benefiting from the objective guidance of professionals.
For DIY investors drawn to AI stocks and other trends, key lessons apply:
- Beware of overtrading: Prof. Statman’s research shows that frequent trading leads to underperformance. Stick to a long-term plan rather than jumping between the latest trends.
- Don’t chase performance: Prof. Barber’s work on Robinhood users highlights the dangers of attention-driven investing. Just because a stock is making headlines doesn’t mean it’s a smart buy.
- Understand your biases: Overconfidence and emotional decision-making can lead to poor outcomes. Accept that you might not always be the most objective judge of your financial strategy and seek professional advice when needed.
- Co-create your financial plan with an objective partner: Collaborating with a trusted adviser or confidant provides a critical layer of objectivity, helping you stay committed to a thoughtful, long-term investment strategy.
In investing, less excitement usually means more success. As Nobel laureate Paul Samuelson put it, “investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”