The Good Investor Rule: Focus on How Not to Lose Money
by Steven Sears
Every year, usually in early spring, much of Wall Street pauses for a moment of silent reflection. Heads are not bowed in remembrance of the fallen, or some historical event. Instead, the silence is in reaction to the somber findings of an annual study that shows many individual investors are trapped in boom and bust cycles of their own making.
DALBAR, a financial services market research firm, recently released the results of their annual Quantitative Analysis of Investor Behavior study. It shows that individual investors have, for much of the past 20 years, significantly trailed market benchmarks, including the S&P 500 index. In 2011, when the S&P 500 had a total return of about 2%, the average equity mutual fund investor lost 5.73%. In 2010, when the S&P 500 rose 9.14%, the average equity investor experienced an annual return of 3.83%. Sometimes, investors have trailed the benchmark by as much as 10%.
In this article
- History, and Mistakes, Repeat
- What Separates Successful Investors
- Strategies for Avoiding Losses
- Your Brain on Money
- One Brain. Two Minds.
- Hindsight Bias
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The study shows individual investors regularly buy high, sell low, and learn little from their experiences. Severe underperformance is troubling enough since so many people rely on the stock market to finance retirements, cover college tuitions, and and pay for most big-ticket items. But there is another pernicious finding.
DALBAR found that investors never stay in the stock market long enough to really qualify as long-term investors. They hold stock mutual funds for an average of 3.27 years. Bond investors and investors who own diversified portfolios are not much steadier. This suggests that individual investors think of themselves as long-term investors, but they actually act like very bad traders. Few people seem aware of the incongruity between their thoughts and actions. Instead, they greed in and panic out of investments. They are often at odds with the natural five-year market cycle, in which a bull market is born, dies, and is born again. If not for inflation and stock dividends, which historically provide about 45% of stock returns, many investors would have sharply smaller investment portfolios.
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