Private investors do not know what rising interest rates do to their investments. Despite this, they said they achieved solid returns even when blood ran through the streets.
The Dunning-Kruger effect, a psychological phenomenon in which people who are incompetent at a particular task overestimate their own performance, seems to have quite a grip on retail bond investors. While six in 10 retail investors say they understand how bonds work, only two per cent of them know the answer to the question of what happens to bonds in a rising interest rate environment.
Critical gaps
This is according to research by asset manager Natixis Investment Managers among more than 8,500 retail investors worldwide. The researchers say that the changing macroeconomic outlook reveals “critical gaps in investment knowledge” among retail investors.
Investors were given four options to explain how rising interest rates affect bonds: 1) Current bond value increases; 2) Current bond value decreases; 3) Future bond income potential increases; or 4) Future bond income potential decreases. In the Netherlands, as many as 99.3 per cent of retail investors gave the wrong answer, while more than half said they did understand.
Investment knowledge gaps
The Natixis surveys also looked at the returns private investors expect on equities, and found that the changing macroeconomic outlook reveals “critical gaps in investment knowledge” among retail investors.
The investors surveyed expect equity returns of 8.6 per cent on top of inflation this year. Interestingly, nearly 60 per cent of investors indicated that monetary depreciation is the biggest concern for their investments. A majority, therefore, want to invest more, but only half actually do so. In the long term, investors expect the average S&P 500 return of over 13 per cent per year.
Losing sight of bigger picture
Only six in 10 investors agree that index funds, which track the broad market, offer returns similar to the market. Two-thirds of respondents assume that index funds help them minimise losses, and 61 per cent think index funds are less risky than other investments.
According to Natixis researchers, retail investors have lost sight of the bigger picture. Only one in 10 retail investors define risk as not achieving their long-term financial goals, while one in five financial advisers define risk that way.
Handling the market
The positive attitude is also evident in the rear-view mirrors of retail investors. While the MSCI All Country World Index ended down more than 18.37 per cent in 2022, investors said they managed an average positive return of 1.9 per cent. In the Netherlands, investors managed to record a 1.3 per cent gain, according to the investors themselves.
Financial advice is of interest to 68 per cent of the respondents, the researchers said, since inflation is again a topic of conversation, but only 51 per cent think they need professional advice for investments. “By their own admission, they can handle the market well,” Natixis said.
“What they may be overlooking now is that the environment of low interest rates and low inflation, which boosted growth for much of that period, has been upended. Essentially, investors need to remember that past performance is no guarantee of future results,” says Dave Goodsell, general manager at the Natixis Center for Investor Insight, speaking to Investment Officer.
For now, a large proportion of retail investors seem to have settled comfortably on Dunning and Kruger’s “Mount Stupid”, nurturing the illusion of knowledge and skill that far exceeds their true understanding.