In a previous post, we talked about the importance of setting your own return objectives, rather than focusing on “beating the market.” A recent study1 out of Dalbar, Inc. provides another perspective on the issue: statistically speaking, if you try to beat the market, you won’t.
This year’s “Qualitative Analysis of Investor Behavior” study lays out not only the statistics of underperformance, but also the most influential factors underlying those numbers.
What were some of the factors?
According to the stats, the average mutual fund investor underperformed the benchmark in all major asset classes over the last year, and fared even worse over longer periods of time — 20 years, 30 years, etc.
It is important to be aware that there are inherent differences between market indexes like the S&P 500 or TSX, and the average investor’s portfolio. There are taxes and other costs that will affect the returns you see from your portfolio versus the growth seen in the index.
The study also found that while traditional diversification is a core strategy for many investment managers, it does not always provide the level of protection its proponents claim, as asset classes tend to become more aligned during market corrections.
What were the biggest factors?
There were two central causes of investor underperformance that vastly outweighed all other factors — one was simply lack of capital. In the right set of circumstances, investing over the long term can work well, but you have to have enough liquid capital to invest, and you have to be able to leave it there for decades. Most investors in the market today have a hard time meeting this requirement.
This leaves the most influential factor in shortfalls of return: behavioural mistakes.
Emotions have a way of swaying decisions, drawing investors away from their initial plans, and undermining the most essential investment principle of “buy low, sell high.”
In our next post, we’ll outline exactly why it is so hard for the average investor to control their emotions and how to go about changing that.