Here's why you're making less than the market
Most stock investors, delighted with their returns in 2013, were blissfully unaware of the magnitude of their underperformance.
Each year, Dalbar publishes the Quantitative Analysis of Investor Behavior. This study analyzes mutual fund inflows and outflows to determine investor returns and compares them to benchmark indexes.
The 2014 study covers the 20-year period from Jan. 1, 1994 through Dec. 31, 2013. During these two decades, the Standard & Poor's 500 Index ($INX) yielded an average annualized return of 9.2 percent while the average domestic stock fund investor earned a 5 percent average annualized return.
This 4.2 percent shortfall is called the “investor gap.”
The investor gap was 6.9 percent last year. Most stock investors, delighted with their 25.5 percent average return in 2013, were blissfully unaware of the magnitude of their underperformance.
Here are some self-induced causes of the investor gap:
Investors are unskilled
Dalbar insists that attempts to correct poor investor behavior through education have failed:
"The belief that investors will make prudent decisions after education and disclosure has been totally discredited."
In other words, investors are financially illiterate and unaware of the long-term consequences of their emotionally driven, short-term investment decisions.
A study by two Cornell University professors, "Unskilled and Unaware of It: How Difficulties in Recognizing One’s Own Incompetence Lead to Inflated Self Assessments," discloses that we often hold overly optimistic assessments of our abilities in subjects in which we are unskilled.
We suffer what the authors call a "dual burden" -- we reach erroneous conclusions and make poor choices but our incompetence prevents us from realizing it. This sad state of affairs needs no explaining to parents of teenagers.
Studies of investor behavior show that the more you look at your portfolio, the more you'll trade. In a study published in the April 2000 issue of The Journal of Finance, authors Barber and Odean reported that investors who traded the most experienced the lowest returns.
Wall Street spends billions of advertising dollars to get you to do something , anything -- just hurry up and start trading. Forget about Barber and Odean -- you can beat the market! This fantasy is Wall Street's biggest lie.
The more you trade, the more Wall Street makes -- which is why there are stockbrokers in every village, hamlet and town in America.
Having no plan
Investors who have a comprehensive, comprehensible written financial plan are less likely to be influenced by the financial media's Apocalypse of the Week.
Good financial planning requires an understanding of capital markets, tax law, employee benefits, insurance and estate planning. Most people lack the time or interest to study these subjects and don't know how to create a financial plan. There's no shame in asking for help. Before accepting investment advice from a financial professional, demand a written financial plan that incorporates your income, expenses, goals, time horizon and risk tolerance.
Investors are repeatedly told that past performance is no guarantee of future returns. Unfortunately, most investors (and their advisers) disregard this warning under the naive assumption that they can find tomorrow's winners by analyzing past performance.
Most will soon find themselves learning a new lesson in reversion to the mean.
Many investors with whom I speak express firm opinions about what the stock market, a particular stock or the economy will do in the near future. I wish I could be so confident.
A study of investors published in "Why Inexperienced Investors Do Not Learn: They Do Not Know Their Past Portfolio Performance" revealed that 70 percent of investors judged themselves to possess above average investing skill and overestimated their portfolios' past returns. The study concluded that most individual investors are incompetent and overconfident -- a dangerous combination, to say the least.
Your portfolio is the sum of its parts. Don't micromanage it by obsessing over the recent performance of each holding. A well-diversified portfolio will always have assets that have recently underperformed expectations. Use periodic rebalancing to reinvest in its underperforming components.
The Dalbar report notes that the average investor holds a stock fund for just over four years:
"At no point in time have average investors remained invested for sufficiently long periods to derive the benefit of the investment markets."
Investor behavior creates the investor gap. Studies of investor behavior reveal that our instincts lead us astray -- we trade too much, make poor market timing decisions and are seduced by strategies and products that promise market beating returns. What investors needed these past 20 years, and will need in the years ahead, is prudent advice about how to receive market equaling returns -- not speculative advice on how to beat the market.
Is your financial adviser following Dalbar's advice and focusing on planning, diversification and maintaining a long-term perspective? Or do conversations with your adviser focus on short-term performance, new investment products and market predictions? One process will minimize the investor gap the other will perpetuate it. You are forewarned. The choice is yours.
--George Sisti, CFP, is a certified financial planner practitioner and the founder of On Course Financial Planning, a fee-only Registered Investment Advisor firm.
More on MarketWatch
--- CASE CLOSED ---
My plan is working great--There is an old saying--YOU CAN BE A PIG AND MAKE MONEY or YOU
CAN YOU BE HOG AND GET SLAUGHTERED. I prefer to just be a pig.
So, the last thing Folks need to do is get into a Contest compared to what others are or aren't doing compared to the past. These same folks might outperform that same group the next ten years. Heck, monkeys throwing darts to pick stocks have outperformed so-called professional Money Managers so really, what's your point anyway.
Ahhh, read the article, a lot I agree with but take issue with some presumptions..
Number one have a Plan is true, even if you need help making it..
Learn about investing and saving, at least a little bit...Research and read...It takes time..
Shop around for Brokers or FAs, ask for track records in writing, see how they invest.
If they decline to be forthcoming....MOVE ON...!!
Diversify your investments, across Sectors and some "not" in Wall St.
Find out actual costs' and lock them in, for a period.
Learn to trade yourself, invest with a large trading house; Lowering fees and cost.
Don't become a day trader with large sums, take advantage of compounding and buy and hold.
Don't be blind to what's going on, it's your money, maybe your livelihood ?
Snowyafternoon....I would definitely have someone else take a look at your 401K, a friend.
Plenty of Index Funds do fine, I've heard; Along with a good ETF they match or better the S&P or other Indices...
Mutual Funds can be okay, but normally have higher fees, and don't perform as well...
Money/Fund managers make the money...
Pretty much think investments in Oil/energy related choices, have OUTPERFORMED the Markets in general, since Bush came to office in 2000-2001..
They have done okay for us...
Who the hell isn't beating the Markets....?? We are STOMPING THEM...
Put the hay in while the Sun shines...
ps....didn't read article..
You have to use Math when doing a Garden, lay outs, row spacings, plant production and amounts needed for eating , storing and/or giving away...Fertilizing/feeding and or water amounts..?
Lots of figurin'.....
Copyright © 2014 Microsoft. All rights reserved.
Specialty apparel is doing incredibly well, with fantastic growth and terrific gross margins.
VIDEO ON MSN MONEY
Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.
Contributors include professional investors and journalists affiliated with MSN Money.
Follow us on Twitter @topstocksmsn.