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The average investor: chronic underachiever

March 28, 2014 by InvestingForMe

DALBAR Inc. is an independent company that develops standards and measurement systems for the investment, life insurance, healthcare and banking industries. According to their latest research, the average investor has underachieved for the past 20 years. They say this is nothing new. In fact, DALBAR finds that if nothing else, the average investor is boringly consistent. It would appear that we’re always under-performing those investment indices (S&P500, Dow Jones, etc.) that we love to watch and use in our carefully crafted financial, retirement and investment plans. And if this case of consistent underachievement weren’t so serious, it would be down right funny.

 

 

Underachieving adds up!

According to a summary chart of DALBAR’s most recent annual study (December 31, 2012), created by Canada’s largest exchange-traded fund company, BlackRock, and financial news services company Bloomberg, the average investors only earned 4.25% per year compared the 8.20% for the stock market. And that’s if you invested 100% of your savings in stocks. If you went for a more balanced investment approach (i.e. investing in stocks, bonds, cash, etc.), you did even worse earning an average of 2.3%! And that’s worse than the average inflation rate of 2.8% over the same 20 years.

That means that the average guy loses out on 3.96% each and every year from their investment decisions. Wow! That’s actually a lot of money you’re missing out on! In other words, for every $10,000 invested, the average guy is making $396 less than the stock market, which over 20 years adds up to over $14,000! That's more than your original $10,000 invested!

But maybe you’re ok with being an underachiever. And maybe you’re ok with taking all the risks that investing 100% of your savings in the stock market entails and earning less than you’re entitled to. Really? I doubt it! But that’s what’s happening for the average investor. Oh, and of course there’ll always be a few investors that do better than the average. And good for them! But this article is not written for those above-average investors. It’s written to try and improve the outcomes for the average Canadian.

3 ways we’re underachieving

Earning only 4.25% when the stock market is making 8.20% is a terrible result. That’s the kind of result that destroys even the best plans – like your financial plan, your retirement plan and your investment plan! And for every year that you allow this shortfall to keep happening, you’re destroying your chances of reaching the goals you have set for you and your family. So, how are we messing up? Well, here’s what the experts are saying.

What DALBAR has found through its more than 20 years of studying investor behaviour is that each and every year there are 3 main reasons for your chronic underachievement.

  1. Bad investor behaviour destroys 2% of your returns. (And that’s not just your bad behaviour, but the bad behaviour of the investment pros managing your investments too!)
  2. Mutual fund investment costs kills another 1.30% of your returns, and
  3. Mutual funds with a High Portfolio Turnover Ratio (PTR) kills another 0.60%. (Remember: Investment pros that generate high PTRs are timing and trading the market - increasing your costs and risks.)

Note: The DALBAR study and their numbers are for U.S. investments, and unfortunately in Canada with our higher mutual fund cost structure, our investment underachievement might actually be greater than the 3.96% our American cousins keep losing.

So, choose wisely

When it comes to making financial plans, retirement plans, or even individual investment decisions, we construct them all using our expectations for future investment returns. And when we can’t predict the future, what do we use to set those expectations? The past, of course! And typically we use the past performance of some investment index (such as the TSX, S&P500 or Dow Jones indices to name just a few of the possible candidates) to help estimate our planned rate of return.

So, if an index’s history tells us that it earned an average return of 8.20% every year in the past 20 years, we feel pretty confident using that 8.20% number in our plans, don’t we? But is that realistic knowing that the average investor underachieves so horribly? Or are we deluding ourselves? For most of us unfortunately, the answer is yes, we are deluding ourselves and we’re going to miss out on a lot of money down the road.

So that leaves you with 2 choices the next time you sit down to prepare or update your financial plans:

  • You can continue to use a lower, more realistic number, maybe 4.25%, in your future planning because you’re crazy and you’re ok with being a chronic underachieving investor, or
  • You can learn from the DALBAR’s 3 main reasons outlined above and take appropriate steps to eliminate your investing underachievement.

Hint: Choose the second option!

Next time, we’ll discuss how you might be able to use an investment’s performance standard deviation (discussed in our previous article) to help combat the #1 cause of investment underperformance – bad investing behaviour.

 

Read the next article in this series - Investor bad behaviour: buy high, sell low

 

 

(Published by TroyMedia)

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