Why do investors get below-average returns on their savings?
Why do most investors get below-average returns on their savings?
Between 1995 and 2015, the S&P 500 averaged a return of 9.85% per year, according to Dalbar Inc research. Over the same period, the average equities market investor returned only 5.19% per year.
Why?
The big-picture answer is “humans are emotional”:
Behavioral barriers to return
When your retirement is on the line, it’s understandable to overreact to new information.
Many investors decide to buy a security after a run of positive news about it. The trouble is, if you’re an ordinary investor, most of that good news has already probably been factored into the price you’re paying for whatever investment you just made. Finding instances where a security is underpriced relative to its long-term value requires a fair degree of legwork and research.
By the same token, investors are prone to panic when the market dips. After the S&P 500 dipped by 13% in late 2018, investors pulled $8 billion out of the markets in UBS’ global wealth unit alone. By doing this, investors effectively locked in a negative return on their portfolio.
Overconfidence
Over-confidence is a common thread among investment sob-stories. The investors trading mortgage-backed securities in the months and weeks leading up to the 2007 financial crisis were undoubtedly very intelligent individuals – the problem was that they knew it and it’s likely that each one thought they had above-average insight into the markets. Overconfidence in the soundness of their own investments, buttressed by herd behavior, helped blind investors to the cliff they were about to run off.
Poor risk allocation
It’s not possible for most people simply to “decide” not to take any withdrawals during a downturn. Market slumps can last for months, and meanwhile life goes on: the house you just bought, the babysitter you hired, the car loan payments you need to make; none of these expenses go down during a recession, but your income might be effected. A stock market downturn that accompanies a recession or personal loss of income would negatively impact both your assets and your income.
This is when individuals are most vulnerable. They may be forced to withdraw from the market to meet an unexpected expense, make a major purchase, or just to maintain current spending after a major loss of income.
If you bought investments in a late-cycle environment, the value of your assets could be trading at a loss months or even years. If your assets aren’t properly allocated across your “risk buckets,” you could be forced to “sell low” in your investment assets.
This is why it’s so crucial to set up an appropriate allocation not only across asset classes, but also to appropriately spread your resources across the several different types of taxable accounts you have
Creating investor discipline
In short, a “buy and hold” strategy may work in the long-term, but its harder to implement than the term suggests.
This is why it’s so crucial to set up an appropriate allocation not only across asset classes, but also to appropriately spread your resources across the several different types of taxable accounts you have at your disposal.