Much has been written about whether financial advisors can help clients generate market-beating investment outperformance.
Amid all of the activity that investors and their advisors pursue in hopeful expectations of outperforming the market, it’s easy to overlook the risk that those activities might create below-market returns. Underperformance can easily come from the unnecessary losses that investors suffer through counterproductive financial and economic behaviors.
Underperformance related to these behaviors can have a far greater negative influence on your investment outcome than the potential and typically smaller positive outperformance that may materialize from your investment manager(s). While we can’t control the performance of the market or an investment manager, we do have control over our behaviors that may lead to returns worse than the market.
Investors can contribute to the creation or destruction of their wealth in the markets, and a preponderance of evidence suggests that the average investor destroys it through suboptimal investing behaviors. Studies from Morningstar and Dalbar, for instance, show that the average mutual fund investor earns returns lower than the returns of the funds in which they are invested. The difference in the results has been popularized as the “behavior gap.”
According to Morningstar, the 10-year gap between the returns of the average investor and the average mutual fund was 2.49% by the end of 2013. The research cites a great example of how market timing can backfire: Money poured out of stock funds in 2009, a year that proved to be the bottom of the market and the absolute best time to get into the market.
A Dalbar report last year drew an even gloomier conclusion. Their research found that the average investor in all U.S. stock funds had earned 3.7% on average each year for 30 years. But the S&P 500 stock index averaged 11.1% annually over the same period. Incredibly, an average stock-fund investor has underperformed the market by about 7.4 percentage points each and every year, for three decades.
The longstanding performance gap has robbed investors of untold compounding power, creating an enormous drag on their long-term results and their ability to meet financial goals such as a comfortable retirement.
Investors’ counterproductive behaviors stem from emotions that are as old as our species ‒ fear and greed. These emotions spur us to abandon well-conceived plans. Greedy for gains, we impulsively change direction to chase a “sure winner.” Fearful of losses, we run in the other direction and sell, effectively “locking in” our losses.
Because the principal in our investment portfolio bounces regularly ‒ moving up and down with the market ‒ we face a never-ending series of emotional triggers that can prompt us to make behavioral mistakes.
In last week’s commentary, we discussed the importance of taking the long view. Are you focused on bouncing principal? That’s the short view, and we believe it inevitably leads to behavioral mistakes. We work to help keep our clients focused on stable and rising income, which we believe is the safest and surest way to meet your long-term goals.
If you would like help staying focused on what may matter most to your investment success, we may be able to help.
At Intelligent Capitalworks, that’s just part what we do.