More Experience Won’t Necessarily Improve Returns
Thursday, July 17, 2014

If you listen to Malcolm Gladwell, you might believe spending 10,000 hours on investing will help you make better portfolio decisions. In his bestselling book, "Outliers" (Little, Brown and Company, 2008), Gladwell cites data from a study linking hours practiced to expertise. Gladwell’s assertion of the number of hours required to gain mastery of a skill is based on a 1993 study of violinists by K. Anders Ericsson and colleagues at Florida State University. The best violinists practiced 10,000 hours, 2,500 more hours than other violinists, according to the Ericsson group.

The Ericsson et al. study is widely cited. If one were to extrapolate its results, a link between the amount of time spent investing and portfolio returns could be drawn. Similar links could be drawn between practice and other activities as well. This is not the case, however. A study recently highlighted by Business Insider argues the amount of practice actually only plays a small role in the mastery of a skill.

In “Deliberate Practice: Is That All It Takes to Become an Expert?,” six researchers analyzed the data from many studies on chess and music. The researchers describe these activities as the “the two most widely studied domains in expertise research.” They found deliberate practice only accounts for 34% of variance in chess performance and 29.9% of variance in music performance.

The six researchers further directly counter Ericsson’s (and thereby Gladwell’s) assumption that a certain number of practice hours leads to mastery. The researchers opine, “Some normally functioning people may never acquire expert performance in certain domains, regardless of the amount of deliberate practice they accumulate.” Extrapolate this statement to investing and it can be concluded that the amount of time spent analyzing securities and the market doesn’t guarantee higher returns.

Making such an extrapolation may not be a stretch. In a study of Taiwanese day traders, those with as much as 10 years of experience still lost money. If decisions with a low probability of producing success are consistently made, failure will follow, regardless of how many hours are logged.

There are certainly many other factors at play when it comes to investing. One of the biggest is the ability to consistently set aside emotions and act in a rational manner regardless what the market is doing. This is far easier said than done. Knowledge, particularly an understanding of the factors associated with long-term gains, plays a key role. So does following a disciplined, well-thought-out approach. Cognitive abilities are another big factor, both from the standpoint of intelligence and from the standpoint of being unimpaired. Luck is a wildcard that can make bad decisions seem good and good decisions seem frustratingly bad. Talent does play a role; some people are simply better at picking investments than others. And, yes, there is a benefit to gaining experience, especially if you are able to learn from what you did right and what you did wrong.

Even if an investor has average levels of investing skill, there are steps he can take to improve his long-term returns. Implementing mechanisms to limit the impact of his emotions is a big one, whether that means using written buy and sell rules or relying on the help of an adviser. Placing greater emphasis on factors historically linked to better returns, such as fundamental strength, attractive valuations, dividends, and even momentum, is also important. Staying diversified limits the blow of bear markets and prevents any one single investment from destroying a portfolio. Finally, it’s critical to focus on the things you can control, constantly focus on the long term and accept the complete lack of control you have over both the direction of the markets and the economy.

More on AAII.com

AAII Model Portfolio Update

There were no transactions in the Model Shadow Stock Portfolio or the Model Fund Portfolio during the month of June.

The Model Shadow Stock Portfolio gained 7.4% in June, outperforming the Vanguard Small Cap Index fund (NAESX), which gained 5.0%, and the DFA US Micro Cap Index fund (DFSCX), which gained 4.3%. For the year, the Model Shadow Stock Portfolio is now down 0.7%, trailing NAESX, which is up 6.4%, and DFSCX, which is up 1.5%. The Model Shadow Stock Portfolio has a compound annual return of 17.8% from its inception in 1993, while the Vanguard Total Stock Market Index fund (VTSMX) has gained 9.4% annually over the same period.

The Model Fund Portfolio gained 2.2% in June. In comparison, the Vanguard Total Stock Market Index fund (VTSMX) gained 2.5%. For the year, the Model Fund Portfolio is now up 7.5%, ahead of VTSMX, which has gained 6.9%. The Model Fund Portfolio has a compound annual return of 9.8% from its inception in June of 2003, while the Vanguard Total Stock Market Index fund has gained 9.4% annually over the same time period.

The Week Ahead

I will speak to our San Francisco chapter this Saturday.

Second-quarter earnings season will hit full stride with approximately 150 members of the S&P 500 reporting. Included in this group are Dow components Coca-Cola (KO), Du Pont (DD), McDonald’s (MCD), Microsoft (MSFT), Travelers (TRV), United Technologies (UTX) and Verizon Communications (VZ) on Tuesday; AT&T (T) and Boeing (BA) on Wednesday; and 3M (MMM), Caterpillar (CAT) and Visa (V) on Thursday.

The week’s first economic reports of note will be the June Consumer Price Index (CPI) and June existing home sales, both to be released on Tuesday. The next reports will be the July purchasing managers’ manufacturing index and June new home sales, which will be released on Thursday. Friday will feature June durable goods orders. 

The Treasury Department will auction $15 billion of 10-year inflation-protected securities on Thursday.

What’s Trending on AAII
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AAII Sentiment Survey

Individual investor optimism about the short-term direction of stock prices fell to an eight-week low in the latest AAII Sentiment Survey. Neutral sentiment rebounded to the upper end of its typical range, while pessimism declined slightly.

Bullish sentiment, expectations that stock prices will rise over the next six months, fell 5.3 percentage points to 32.4%. This is an eight-week low. This is also the 16th time in the past 18 weeks that optimism is below its historical average of 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rebounded by 5.5 percentage points to 39.2%. This puts neutral sentiment above its historical average of 30.5% for the 28th consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, declined 0.2 percentage points to 28.5%. The decline puts pessimism below its historical average of 30.5% for the 13th straight week and the 36th out of the last 40 weeks.

Neutral sentiment is right at the upper end of its typical range. Readings above 39.4% are considered to be unusually high (more than one standard deviation away from average.) The current 28-week streak of above-30.5% readings for neutral sentiment ties a similar streak from 1993 for the third-longest in the survey’s history. The only longer such streaks were an 82-week stretch between 1987 and 1988, and a 65-week stretch between 1997 and 1998.

Uncertainty about the short-term direction of stock prices, combined with a backdrop of concerns about prevailing valuations, a wait-and-see approach about second-quarter earnings, and, for some individual investors, rising tensions in the Middle East all likely played a role in boosting neutral sentiment and lowering optimism. Some AAII members remain optimistic about sustained economic growth, the market’s upward trend and the Federal Reserve’s tapering of bond purchases. Others fret about the pace of economic growth, prevailing valuations, events in the Middle East and Ukraine, and frustration with Washington politics.

This week’s special question asked AAII members what type of impact, if any, the current events in the Middle East are having on their six-month outlook for stock prices. Nearly half of respondents (49%) said the events so far were either not impacting or having a very small impact on their outlook. Slightly more than one out of five respondents (21%) said the events were either causing them to reduce their expectations about how stocks will perform or were a cause for concern. Just 12% said they were more bearish because of the events in the Middle East. Some members noted that their outlooks would change if geopolitical events worsened.

Here is a sampling of the responses:

  • “None. There is always something going on somewhere. I just tune it out.”
  • “I would expect oil and gas prices to go up, creating a slight drag on the economy.”
  • “Currently none, but things can change quickly over there.”
  • “Some concern changing my sentiment on the market from bullish to neutral.”
  • “Major impact due to possibilities of expanded conflicts.”


This week’s Sentiment Survey results:

Bullish: 32.4%, down 5.3 points
Neutral: 39.2%, up 5.5 points
Bearish: 28.5%, down 0.2 points

Historical averages:

Bullish: 39.0%
Neutral: 30.5%
Bearish: 30.5%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!


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