Research released by Dalbar presents a grim evaluation of individual investors. The study reveals that over the 20 year period from 1982-2012, the average equity fund investor has earned an annualized return of 4.25%, while the S&P 500 has an annualized 8.22% return. This begs the question: Why is the individual investor losing nearly 4% annually? Behavioral finance offers some explanations as to why investors are consistently making poor decisions. Many of these behaviors will be discussed in future blog posts, but we will focus on the “buy high and sell low” dilemma in this post.
Recent history shows us clear examples of “buying high and selling low.” When the global markets were expanding in 2006 and 2007, many investors were just starting to buy into equities based on their recent excellent performance. On the flip side, when the economy was crashing all around us and stock prices were plummeting in 2008, what were the same investors doing? Instead of buying stock funds at extraordinarily low prices, they were selling equities and buying bonds. Another example of this was during the dot-com bubble in 1999: investors were pouring record sums of cash into technology mutual funds which had just risen by 900%. Regrettably, they were investing at the peak of the market and only months later saw their portfolios plummet in value.
In both cases, investors were “buying high and selling low,” the exact opposite of what common sense dictates. It is human behavior to WAIT to buy an investment until it has done well. The problem with this is that by the time the investment is made, it has risen to the point where the gains have already occurred, leaving little room for additional appreciation.
This is where the financial advisor comes into play. The value of a financial advisor is not just to make investment decisions on your behalf, but to help prevent you from making poor, emotionally-driven investment decisions that will harm you.
Image provided by Carl Richards at www.behaviorgap.com
