In the last edition of RETIREMENT GAMEPLAN, I shared DALBAR’s Annual Quantitative Analysis of Investor Behavior (QAIB) results.
As a refresher, according to DALBAR’s 2020 QAIB, the average stock fund investor earned only half of what the broad stock market index earned each year over the last 30 years.
From January 1990 through December 2019:
- 9.96% per year: Average annual return of the S&P 500 stock market index (with dividends reinvested)
- 5.04% per year: Average annual return of average stock fund investor (i.e. not a fund, but a person)
The question we always have to ask after reading these disturbing results is why?
Why do the investment results of the average stock fund investor so drastically trail the most basic index of broad stock market returns year after year?
The only two logical possibilities are:
- “how” they invested, i.e. when they bought, when they sold, what they chased, what they were scared out of, etc., i.e. their investing behavior, and
- the fees they paid, which ate into their returns.
Let’s closely examine these root causes so we can help you avoid these horrific results and close this gap!
More Destructive Investor Biases You Must Avoid
In the last edition, we dove into some of the root causes by examining some of the debilitating biases most investors bring to the table. Before examining the second reason investor returns are so low compared to market index returns (i.e. the fees they pay), let’s examine a few more investor biases so you can close this gap!
- Overconfidence Bias: Overconfidence Bias comes from an underlying belief that you or anybody can consistently predict the future, and benefit from it.
The only rational and educated answer to this question is no. If only 17% of active mutual fund managers have beaten their respective index in a given year with the wealth of information and talent around them, what is the probability that any of us can have a long-term advantage over them?
And, the 17% is not the same list each year, i.e. the managers who beat their respective index in 2020 is a completely different list than those who did so in 2019!
- Greed Bias: Another debilitating bias is Greed. This comes from the desire to hit “home runs.” In essence, this is gambling.
Gambling occurs when you don’t use high levels of probability to obtain the outcome you want and need. I see this with some of the folks I’m introduced to whose investments are not linked to stated long-term goals, like those entrenched in cryptocurrency trading at the moment, i.e. Bitcoin, etc.
Or, their investments are not linked to reality, i.e. seeking something that doesn’t exist like market returns without market volatility.
In essence, they’re looking for something that any rational person knows does not exist.
- Staying Home Bias: While the share of the value of the world’s companies headquartered in the United States is only 52%, Americans invest 76% of their wealth in American companies.
This may sound patriotic, but it doesn’t make much sense from an investment perspective. 48% of the world’s capitalization lies outside the U.S. in thousands of profitable companies.
Staying Home Bias occurs when you place a higher value on a company headquartered in the U.S. simply because it’s home office is located here.
A great example of this is Toyota. Although their headquarters are in Japan, far greater than 50% of Toyota cars are purchased by Americans.
- Negativity and Loss Aversion Bias: I saved the strongest one for last. Loss Aversion Bias stems from the ingrained “fight or flight” defense mechanism in our brains.
While that served cavemen well, and saved lives, it is incredibly destructive for long term investor success.
The key to overcome this is education and consistent reinforcement in good and bad market climates, i.e. a rational understanding and realization that market corrections and crashes are normal and temporary, and simply part of your investment experience.
- Since 1980, the S&P 500 Index has experienced a peak-to-trough intra-year market correction of 14% per year, i.e. at some point during the year, prices fell 14% on average.
- Since 1945 (74 years), there have been 92 stock market pullbacks of 5% or more.
- 89 of the 92 pullbacks recovered in 14 months or less, and 80 of those 92 recovered in 4 months or less.
In spite of all of these, market prices and dividends have risen dramatically outpacing inflation by 7.3% per year.
While this is challenging to remember during turbulent times, nobody earns market returns without experiencing market turbulence, corrections, and crashes.
As legendary investor Peter Lynch said, “more money is lost anticipating market crashes than the crashes themselves.”
Confidently living the life you’ve earned after your retirement transition requires successful strategies and mindsets.