Investor vs Investment Returns

Is there any proof that behavior matters in investing?

One way to find out is to see how investors’ actual returns compare to the investments they use. That is: if you invested in a mutual fund, did your returns match the returns earned in the mutual fund (and go along for the ride) or did you lag behind?

A study by Dalbar, Inc has shown year after year that investors don’t do as well as their investments. They’d do better if they did less.

Assume that investments are “the stock market”. Investors try to earn market-like returns by investing in the markets, but they generally fail.

Instead, they earn about 7% less per year on average – give or take a percent depending on which year’s study you look at.

For example, if the markets provided average annual returns of 11% over a 20 year period, people investing in the markets might have earned a 4% average annual return. These are just rough numbers, but they haven’t changed much over time. What happened to that 7%?

Bad behavior took it away. The study shows that investors switched investments frequently, and only stayed for relatively short periods of time – three years or so. The idea is to buy low and sell high, not the other way ‘round. However, switching investments frequently makes success less likely.

Sure, emergencies come up from time to time and you may need to sell. But the study shows the problem is widespread. In a world where the TV tells you that you should constantly do something about your investments, it’s not a big surprise. Even if you somehow get the right information, you can do the wrong thing: just look at the best performing fund for the period of 2000-2010. It earned roughly 18% per year, while the average investor in the fund lost 11% per year.

You can view a summary of the Dalbar study for specifics (yes, it’s a few years old, but the lesson doesn’t change much from year to year).

The lesson: your behavior is important. Form a strategy and stick to it unless there’s a really good reason not to.

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