“Don’t just do something, stand there!” is easier said than done. All investors have a breaking-point. And most believe it to be higher than it really is. That’s why it’s important to learn from the past and establish the right portfolio for your emotional make-up. I like the work The WSJ’s Jason Zweig references here in his piece “Just How Dumb Are Investors?”:
A new study finds that the average investor in all U.S. stock funds earned 3.7% annually over the past 30 years—a period in which the S&P 500 stock index returned 11.1% annually. That means stock-fund investors underperformed the market by approximately 7.4 percentage points annually for three decades, according to Dalbar, a financial-research firm in Boston that has updated this oft-cited study each year since 1994.
How is that possible? The return of a fund—or a market index like the S&P 500—is calculated as if investors put all their money in at the beginning and keep it there, untouched, until the end of the measurement period. But most people put money in and take it out along the way—investing a recent bonus, making a housing down payment, paying tuition, withdrawing money in retirement.
Making matters worse, most funds lag the S&P 500, accounting for roughly one percentage point of the gap Dalbar finds between the performance of investors and the broad market. Fees and expenses account for at least another percentage point.
But the biggest factor is that investors chase returns—jumping aboard after a streak of hot performance and diving over the gunwales after it goes bad. Because of that buy-high, sell-low behavior, investors in the typical fund have a lower average return than the fund itself.
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