Much has been written about investment behavioral mistakes and 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.
Investment Behavioral Mistakes Lead to Investment Underperformance
Underperformance related to investment 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.
Independent studies continue to show that the average mutual fund investor earns returns lower than the returns of the funds in which they are invested and the returns of the market. The difference in the results has been popularized as the “behavior gap.”
Since 1994 Dalbar, a financial-services research firm, has prepared annual studies entitled “Quantitative Analysis of Investor Behavior.” The results of their studies continue to find that the average investor in all U.S. stock funds earns less than the returns of the S&P 500. Remarkably, this underperformance also applies to the average investor in S&P 500 Index funds as well.
Through yearend 2021 here are the sobering findings:
For the 30-year period ending 12/31/2021, the average equity fund investor earned a 7.13% compound rate of return, underperforming the 30-year 10.65% compound rate of return of the S&P 500 Index by an average of 3.52% per year.
For the 20-year period ending 12/31/2021, the average equity fund investor earned a 8.13% compound rate of return, underperforming the 20-year 9.52% compound rate of return of the S&P 500 Index by an average of 1.39% per year.
For the 10-year period ending 12/31/2021, the average equity fund investor earned a 13.44% compound rate of return, underperforming the 10-year 16.55% compound rate of return of the S&P 500 Index by an average of 3.11% per year.
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.
Investment Behavioral Mistakes are Counter-Productive
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.
Are you focused on bouncing principal? That’s the short view, and we believe it inevitably leads to behavioral mistakes. To help overcome the challenges and related costs of punishing short-term investment behavioral mistakes, we discuss the importance of taking the the long view. 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.