Lagging Returns? It’s Your Fault

Why does the average stock investor do worse than the market? Because he or she buys and sells at the wrong time, often reacting to news events. In other words, it’s the investor’s own fault, not that of mysterious financial forces.

We have a hard time believing that our own actions could be the cause of our investments performing lower than the overall market. I was investing my own 401(k) assets while working at Chase Manhattan Bank in early 1991. The news of the day was the U.S. imminent attack on Iraqi forces, which had invaded Kuwait.

This was before I became a financial advisor, and I followed the pundits who stated that the stock market would sharply decline when this military action occurred.

Even though my investment time frame then was over 50 years, I switched my 401 (k) asset allocation heavily to bonds, and thus out of stocks. When the U.S. attacked, the pundits were wrong. The stock market did respond strongly, but in a positive direction.

My actions caused me to miss out of the stock market gains. Did this ever happen to you? I learned from that lesson and now try to help others to avoid making these same mistakes.

Every year the research firm Dalbar does a study that tries to quantify the impact of investor behavior on real-life returns by comparing investors’ earnings to the average investment (using the Standard & Poor’s 500 as a proxy). The S&P 500 index captures the largest publicly traded companies in the U.S.

The latest study looks at the average annual performance over the 10 years that ended Dec. 31, 2012:

  • S&P 500 return = 8.21%
  • Equity investor return = 4.25%

That’s quite a gap. If you had put money into an S&P 500 index fund 10 years before and just left it there — no buying, no selling, just investing and forgetting about it — you earned (minus fees) a little bit above 8%. Remember, this period included the Great Recession and the 2008 loss of over 38% in the S&P 500.

So why did the average stock investor only earn 4.25% during this same period? The investor sold stocks in 2008 and later at a low, or purchased others at a high. The person listened to the pundits and reacted to the news of the day throughout this 10-year cycle.

We have a saying, called “behavior gap,” to explain the disparity. It’s the difference in return investors get versus the investments that they own.

What is really dismaying is how little this seems to change over the years. When it comes to investing, the tendency to behave badly is not going away.

So what do you do about it? Realize there’s a tendency to emotionally react to current events, and work with someone to help you have the discipline and patience to stay with your plan.

For most of us, money is bound up with powerful emotions such as security, confidence and sometimes fear. But the emotions of investing can cause you to lose focus on important areas of your financial life, most of which have absolutely nothing to do with the stock market.

The way our brains are hard-wired can cause us to make emotional decisions about our money at precisely the wrong moments.

The reality is investing successfully is hard. But by focusing on our behavior, we can close this gap in the next 10 years. Work with a competent advisor to help you stayed focused on your long-term objectives.

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Dan Crimmins is the co-founder of Crimmins Wealth Management LLC in Woodcliff Lake, N.J. His blog is Roots of Wealth.

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