Is The Market Smarter Than You?
Statistically speaking, yes.
We are often our own worst enemy when it comes to investing. Buy this stock, sell that one, exit the market entirely, over-concentrate into one specific sector, etc., our choices and behavior can keep us from earning a market average return.
To track just how far we fall short, a company called Dalbar releases an annual Quantitative Analysis of Investor Behavior (QAIB) study that compares stock market returns with those of actual investors. This is the performance of real people, like your friends, neighbors and relatives. What Delbar and others consistently find is that we are, collectively, seriously bad investors.
How bad you might ask?
Well, in 2014 the average equity investor made 5.5%, while the S&P 500 index returned 13.7%. Said differently, real investors performed 60% worse than the market. Granted, the S&P 500 is one benchmark against a host of possible equity indices. In addition, others have taken issue with some of Dalbar’s methods for calculation. Still, study after study shows that investors routinely underperform the market overall.
How big of a difference can this make?
A lot.
For example, $10,000 invested over 20 years grows to $26,533 at a 5% return, but grows to $67,275 at a 10% return. This is over 2.5x as much.
Now picture a lifetime of this. The cumulative effect will be hundreds of thousands of dollars, if not more.
What are some common mistakes?
1. Market timing. Hopping in and out of stocks is a time-tested method for underperforming the market. Few (no one?) can consistently time the market. Further, study after study show the importance of being in the market at the right time to take advantage of a few periods of high returns. Better to ride out the peaks and valleys.
2. Switching to “hot” mutual funds. One fund is riding the wave of good stock picks, the other is in the basement. By purchasing the former while it is doing well you are essentially “buying high,” while getting out of the latter is “selling low.” There are many reasons to purchase and sell, catching the wave of a hot fund shouldn’t be one of them.
3. Fees. Investment management fees, sales expenses, record keeping costs, and other fund-related activities can equal 10, 20 sometimes 30% or more of the market’s return in a given year. Keep fees low where possible.
4. Taxes. Funds and investors often overlook the impact of taxes on active trading. A “buy and hold” strategy is very tax efficient for the long-term investor, as most of the gains will be taxed at capital gains rates, as opposed to a higher income tax rate. High fund portfolio turnover can be costly during tax season.
Investors often have their own objectives and time horizons, but in the end all are trying to generate the highest risk-return available. Yet studies show when we reach for more we often end up with less. Instead, and unlike many of life’s other pursuits, we should aspire to be “average.” Surprisingly simple, and far less time consuming, the advantages of being average can compound over the years into truly life changing balances. Good news, if not necessarily intuitive.
Thanks for reading. Comments and suggestions for other topics welcome.
Below are a few posts on my experience with money and the financial industry in general:
· “Money Advice for Millennials: How to Save for a (Not So) Distant Future”
· “How Bank Fees are Nudging Us to the Right Answer”
· “Your 401(k) and the New Rules of Retirement Savings”
· “Retirement Savings and Healthcare Costs: A Balancing Act”
Below are reviews of popular titles in the financial space:
· John Bogle (the co-Founder of Vanguard) “The Clash of Cultures: Investment vs. Speculation” here.
· Ric Edelman, the founder of Edelman Financial, “The Truth About Money: Everything You Need to Know About Money” here.
· Lars Kroijer’s “Money Mavericks: Confessions of a Hedge Fund Manager” here.
· Eric Tyson’s, “Investing for Dummies” here.
I’ve also written about nutrition, health, behavior and other (mostly) related topics. On LinkedIn and Medium.
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