As a whole, investors have received a very poor performance report. Dalbar – a well-known financial research firm – has been studying the returns of individual investors for over thirty years. Their findings have discovered that overall most investors perform badly, and there’s a major negative discrepancy between what investors earn, and what the markets they actually invest in earn.
Take the S&P 500, for instance. It’s a market that nearly everyone is invested in, and it has historically averaged around a 10 percent return. Investors in the S&P 500, however, have been found to earn around 7 percent less than that.
In investing circles, this discrepancy is known as the “Investment Behavior Gap.” As the name suggests, though, there is a silver lining to the findings – like any other behavior, it can be corrected.
Why most investors perform badly
A large reason for why most investors perform badly is our emotions. Since the beginning of time, humans have used emotions and intuition to survive and evolve. Naturally, we use those very same instincts – such as fear and confidence – to make investment decisions.
While primal instincts still keep us away from real danger, they don’t necessarily apply to modern things like the Dow Jones. More often than not, gut reactions are completely counterintuitive to investing success.
Let’s look at one of the most base and burning instincts: fear. When the stock market is on a downturn, fear will cause you to start selling your stock investments, just like it would lead you to flee a burning building or run from a predator. In this case, it will have the opposite effect: you’ll sell your stocks at a low point, and end up missing out on their eventual recovery. It’s no small wonder most investors perform badly.
How to avoid the gap
You can start closing in on the investor behavior gap by recognizing that your emotions shouldn’t necessarily apply to investing. Although this isn’t easy, a great way to do this is through financial goal-setting. By creating long-term financial goals – like retiring a millionaire or buying a house – you have a concrete goal to tie your decisions to. You’ll (hopefully) be prevented from making rash, emotional decisions when your performance depends on sticking with the program.
It can also be a wise investment to utilize a trusted advisor, who can serve as a rational coach for your long-term goals and needs. The right advisor can keep you grounded and prevent you from making emotional investment decisions.
If you’d like to learn more about investing, check out my firm LexION Capital.