Why Do-It-Yourself Investors Do So Poorly
A recent study was published by Dalbar examining how well regular investors performed over time compared to the stock market as a whole. The results were striking. Since 1988 the stock market has returned on average 10% per year (2020 very well may lower this number). Regular investors on the other hand, returned only 4.1%. Incredible. What is going on here? If a regular investor can very easily, and cheaply, buy an index of the U.S. stock market, not touch it for 30 years, and attain the 10% per year average return, then why did average investors underperform so significantly?
The reason why is quite simple. Investors tended to sell their investments when stock markets declined, only to buy their investments back after the stock market recovered. Thus, locking in significant losses when they sold and missing the profitable recovery before they re-invested their money highlighting a delta between investment returns and what most investors actually received. Carl Richards the prescient writer and thought leader in behavioral wealth management calls this delta The Behavior Gap and elaborates on the concept:
“You earn the investment return if you invest your money and then don’t touch it. No buying, no selling, just holding. But real people rarely invest this way. Real people chase performance and invest by looking in the rearview mirror. It is precisely the hunt for the best investment that creates a phenomenon I have called The Behavior Gap, the result of which is well documented. Because of classic behavioral mistakes, average investors almost always do worse than average investments.”
This begs the question, what is the right way to invest your savings to achieve your goals? With high quality investment options becoming more widely available and more affordable day by day, managing your behavior is just as important as managing your investments. Warren Buffet was famously quoted as saying “Our favorite holding period is forever.” The regular review of understanding where you are, where you want to be, and the gaps needed to get there is the key to making wise decisions with your investment money. When investors understand what they are investing for and when they will need their investment savings, they can manage their behavior appropriately.
Perspective is everything and Ron Blue, the father of Christian Wealth Management likes to tell his client’s that the longer perspective you take, the wiser decision you can make. For example, if you are saving for retirement which you plan is 20 years in the future, short term ups and downs in the market should not cause you to bat an eye. However, if your retirement date is set for the end of the year, short term ups and downs in the market will cause you to lose sleep (and should!) meaning the prudent way to your manage your investments would be conservatively, ensuring you won’t compromise your quickly approaching retirement. The principles hold for college planning, a big trip, or a new business venture. When we understand where we are going and the purpose for our investing, we can clear unhelpful emotions from our decision-making process and instead make wise decisions which will best lead us to achieving our goals.
Reality dictates that we will never be able to take all of our emotion and behavioral biases out of our decision making, especially when it comes to our money. When the stock market drops, even though we know selling our investments would be a mistake, it’s scary. Or when it seems as though everyone is making a killing on the new unknown stock or crypto currency, although we know those gains are likely short-lived, we feel the bitter pangs of missing out. This is why it’s so important to be aware of the behavioral pitfalls we can unknowingly fall into as humans and investors.
Eric Schrum is an advisor and partner at Schrum Private Wealth Management. Eric contributes for The Faith First Advisor, The Faith Driven Investor, and has a particular interest in helping Christians align their finances with their beliefs through wise financial planning and investing. Investment Advisor Representative of Spire Wealth Management, LLC. Advisory Services offered through Spire Wealth Management, LLC, a Federally Registered Investment Advisor. Securities offered through an affiliate, Spire Securities, LLC. Member FINRA/SIPC.