3 Reasons Why Average Investors Can't Beat the Average Market Returns

In the intricate world of investing, one factor often escapes attention yet significantly shapes success: the mindset and behavior of the investor. Through in-depth analysis, Dalbar, Inc., a firm specializing in studying investor behavior, has unveiled an unsettling truth. Over the last 20 years, culminating on December 31, 2019, the average investor has persistently underperformed. While the S&P 500 Index secured a 6.06% average per year, equity fund investors trailed with a mere 4.25% return. Why this wide disparity? What hidden obstacles are at play, and how can you navigate these barriers to secure financial success?

Section 1: The Emotional Quagmire of Investment

Buying High: A Common Mistake with Far-Reaching Consequences

• The Trend: It's a pattern that baffles seasoned financial experts. As stock market prices soar, investors eagerly invest more. Conversely, when prices plummet, they hastily withdraw. This is akin to a shopper buying a product at a high price and then returning it during a sale.
• The Consequence: This contradictory behavior can lead to returns far lower than the historical stock market averages. The question is, why would an investor knowingly act in such a detrimental manner?
• The Solution: Avoiding this pitfall requires a disciplined strategy. Rather than falling prey to market whims, investors should aim for a diversified portfolio, perhaps involving index funds, that aligns with long-term aspirations. By avoiding the temptation to chase fleeting market trends, investors can position themselves for more stable, long-term gains.

Overreacting During Uncertain Times: An Investor's Achilles Heel

• The Human Reaction: Whether in response to positive or negative news, human beings tend to react emotionally. In investment terms, these emotional impulses can trigger hasty decisions, particularly during times of personal or economic uncertainty.
• The Field of Behavioral Finance: There's more to this phenomenon than meets the eye. A dedicated field called "behavioral finance" explores the tendency to make impulsive financial decisions, using terms like "recency bias" and "overconfidence" to identify these costly mental traps.
• How to Stay Grounded: Recognizing and understanding these biases is half the battle. By staying conscious of the emotional undercurrents driving financial decisions, investors can maintain a level-headed approach, even in turbulent market conditions.

Investors, the Future, and the Overconfidence Paradox

• The Overconfidence Bias: The belief that one's skills are above average is a common human trait. In the investment world, this overconfidence can manifest in the belief that one can predict future events based on past data.
• The Reality Check: Sadly, overconfidence often leads to misguided investment decisions. No matter how skilled, predicting future market events with precision remains an elusive goal.
• Guidance and Education: Professional guidance can help avoid the overconfidence trap. Investors must seek to understand their biases, consult with experts when necessary, and build a resilient strategy grounded in factual analysis rather than mere belief.

Section 2: The Path to Wise Investing

The Essential Role of Professional Guidance

• The Emotional Barrier: Emotions, although integral to our humanity, can lead us astray, prompting impulsive and costly financial decisions.
• The Role of an Advisor: By hiring a financial advisor, one can create a buffer between these emotions and vital investment decisions. An adept advisor aligns your financial goals with market realities, ensuring that decisions are made rationally rather than emotionally.
• Finding the Right Fit: Choosing an advisor is an individual journey. Ensure that the chosen professional resonates with your investment philosophy and long-term financial goals.

Four Key Investment Strategies to Live By

1. Do Nothing – A Conscious Choice: In fluctuating markets, the best action is often inaction. Assess your long-term goals, and if they remain unaltered, maintain your course regardless of short-term market shifts.
2. Handle with Care – The Wisdom of Less Handling: As the economist Gene Fama Jr. insightfully stated, “Your money is like a bar of soap. The more you handle it, the less you’ll have.” Frequent trading can erode returns, and patience often pays off.
3. Bear Market Wisdom – Resist the Urge to Sell in a Down Market: If you have allocated your funds correctly, never sell equities during a down market cycle. Just as you wouldn't sell your house in a declining housing market, don't panic and sell equities during a bear market. Wait and be patient.
4. Trust the Science of Investment – Boring but Effective: A disciplined approach, while possibly less exciting, is often more rewarding. If you lack this discipline, consider professional management.

FAQs: Navigating the Intricacies of Investing

Investing Before IPOs – Understanding the Limits

• The Question: Can average investors buy into companies before they trade publicly?
• The Answer: Regulations often restrict this high-risk investment strategy to accredited investors who meet specific financial benchmarks. An average investor must be wary of the risks involved and adhere to regulatory guidelines.

Uncovering Opportunities – The Sophisticated Investor's Approach

• The Question: How do sophisticated investors find investments that average investors miss?
• The Answer: Sophisticated investors often outperform through a unique "trading edge," focusing on areas like business financials or market trends. This specialized, honed approach enables them to uncover hidden opportunities, elevating their investment game.