Dalbar Inc. is a company which studies investor behavior and analyzes investor market returns. The results of their research consistently show that the average investor earns below average returns.
For the twenty years ending 12/31/2010 the S&P 500 Index averaged 9.14% a year. A pretty attractive historical return. The average equity fund investor earned a market return of only 3.83%.
Why is this?
Investor Behavior Causes Poor Market Returns
Study after study shows when the stock market goes up, people pour money into equity mutual funds, and when the market goes down, they pull money out. During bear markets, they pull even more money out. They continuously buy high and sell low. They chase trends, focused on what is happening right now.
This irrational behavior causes their market returns to be substantially less than historical stock market returns.
What would cause investors to exhibit such poor judgment? After all, at a 9% return, their money would double every eight years. Rather than chasing performance, an investor could simply have bought a single index fund, and earned significantly higher returns.
The problem is the human reaction, to good news or to bad news, is to overreact. This emotional reaction causes illogical investment decisions. This tendency to overreact can become even greater during times of personal uncertainty; near retirement, for example.
4 Truths To Follow To Increase Your Market Returns
When it comes to your investments, if you feel your emotions are getting the best of you, come back to the following truths:
- Do nothing. A conscious and thoughtful decision to do nothing is still a form of action.
- Your money is like soap. To quote Gene Fama Jr., a famed economist, “Your money is like soap. The more you handle it, the less you’ll have.”
- Never sell equities in a down market. If your funds are allocated correctly, you should never have a need to sell equities during a down market cycle. This holds true even if you are taking
income. Just as you wouldn’t run out and put a for sale sign on your home when the housing market turns south, don’t be rash to sell equities when the stock market goes through a bear cycle. Wait it out.
- Science works. It’s been academically proven that a disciplined approach to investing delivers higher market returns. Yeah, it’s boring; but it works.
Start following these truths now and become one of the few investors earning above average market returns.
For more ideas, see 10 Ways to Become a Better Investor.