Have you ever felt like your investment portfolio doesn’t seem to grow as much as the market in general?
Or maybe you’ve had a nagging feeling that your portfolio is underperforming for some reason? And you can’t quite figure out what the reason is.
Well, there’s good news and bad news…
The good news is, you are probably right. Which means you’re not crazy.
The bad news is, well, the same thing. You are probably right and there’s a good chance your portfolio is underperforming the market.
There is actually data to back up this phenomenon of how the average investor typically underperforms the market.
Each year a company called DALBAR releases a report called “Quantitative Analysis of Investor Behavior.” Around the beginning of each year they calculate how investors did in the prior year. I am eagerly awaiting the latest edition that will tell how investors did in 2015.
Here is a chart from that report with a link to the excerpt:
The average equity investor got 3.79% over the 30 year period ending 12/31/2014. This is compared to the S&P 500 returns of 11.06% for the same period. So it’s actually worse than half of what the large-cap US equity market did over this 30 year period.
The 3-year period looked a little better with the average equity investor getting 14.82% return. This only underperformed the S&P 500 by 5.59% (20.41%-14.82%=5.59% underperformance). Much better, but still not ideal.
What’s The Cause of Investor Under Performance?
According to the link above, the reason investors underperform is due to making bad “decisions at critical points.” It says,
“The underperformance results from bad investor decisions at critical points, the first in the face of severe market declines and the second when the equity market surged.”
What this means is at the critical points investors made the wrong decisions. In other words, when markets went down they panicked and sold after taking losses. And when markets rebounded they were not invested as heavily (probably because of the previous panic selling) to take advantage of the growth.
Another way to describe this type of behavior is “selling low and buying high.” It’s not the best plan for investors to do this… to put it mildly.
Another problem that plagues investors is chasing after returns. Perhaps you see an investment news (read: entertainment) show on television. And you see the talking heads talk about how much the “XYZ Fund” (fictitious fund for argument’s sake) has grown.
And you start to look at your portfolio, and it hasn’t grown as much as the “XYZ Fund.” This leads to the temptation of buying into this fund in the hopes that it will continue to go up.
As a general rule, if you are seeing the information on TV, the markets have already priced all that information into the value of the stock (or fund) at the moment. You are not going to get “insider information” from a broadcasted TV show. This information is not going to give you a “leg up” on the big institutional investors.
The problem with chasing returns is that you may have sold shares in your existing portfolio to purchase the so-called hottest new “XYZ Fund.” And perhaps the portfolio you already had was a good one in line with your growth needs and risk tolerance.
Doing this could upset your original investment plan.
What Is The Solution To Investor Under Performance?
The solution is to have a long-term view on how you invest your money. And then here’s the tough part… You have to stick with it.
This can be very difficult.
Going back to the chart at the beginning of the article. If an equity investor had stuck through thick and thin with a fund that tracked the S&P 500 they would have done much better than paltry 30 year annualized returns of 3.79%.
But that is difficult to do for most investors.
It’s not only difficult because the market can be volatile and scare investors. But it can also be difficult for a retired investor that must make withdrawals from the portfolio.
One of the worst things that can happen to a retiree is they retire right before a big market correction. It can take years to recover. And in the meantime they may be withdrawing from their portfolio to supplement their income sources.
This further reduces their portfolio.
And this isn’t really an argument in support of only investing in the S&P 500 for all of your portfolio. It generally still makes more sense to be diversified with other asset classes, like bonds, REITS, international equities, etc.
But the point is that investors oftentimes are sabotaging their own investment plans by
- Not sticking to their plan with a long-term perspective, and
- Not having an appropriate portfolio for their needs. A retired investor will likely need to draw income from their portfolio, which means they will likely need a different mix of investments than a person that is decades away from retirement.
Another Way To Help Solve Investor Under Performance
One thing that makes it very difficult to stick with a portfolio is when it has a lot of volatility. Smoother results are easier to stick with than highly volatile results.
If you have a portfolio that goes up and down dramatically in the market it is easier to be more prone to panicking when the market has a correction.
That’s why it is important to do 3 things:
- Make sure you understand how aggressive your portfolio is. Typically the more growth potential your portfolio has, the more risk it will take. This will typically mean it has more volatility. Make sure you know how much volatility is in the portfolio and if you are comfortable with it.
- Use an appropriate mix of investments in your portfolio. The more volatility scares you, then perhaps you will want more investments in your portfolio that are less aggressive.
- Diversify your portfolio. This is the same thing as not putting all your eggs in one basket. If one asset class in your portfolio is doing poorly, perhaps there will be others that are performing better to offset it. This helps reduce volatility
It’s a shame that the average investor is missing out on more potential growth. That’s why you have to think long-term when it comes to investing. There’s a lot at stake when it comes to investing for your retirement.
To help you out with this, check out my e-book “Top 7 Investor Mistakes Baby Boomers Make With Their Portfolios… And How To Help Avoid Them” to understand and help you avoid some very common mistakes.