Why Individual Investors Do So Poorly In The Market

Here is a sobering statistic for you: While the S&P 500 has generated annualized returns of 9.9% over the past 20 years—and a boring old asset allocation of 60% stocks and 40% bonds has managed to return a solid 8.7%—the average investor has eked out a measly 2.5%.

Inflation has averaged 2.4% over the past 20 years, meaning that in real terms the average investor has returned pretty close to zero. And this during one of the best periods in this history of the U.S. stock market.



Source: JPMorgan

How are returns that bad even possible? If the Efficient Market Hypothesis is to be believed, investors should roughly track the S&P 500 over time, not underperform it by 75%.

There are a myriad of answers, including everything from overtrading to underdiversification, but the biggest contributing factor is peformance chasing. Investors don’t park their cash in the stocks or sectors promising the best value. They jump on whatever is trendy in a perpetual case of closing the barn door after the horse has already bolted.

Late last year, veteran financial writer Mark Hulbert crunched the numbers and found that following the investment newsletter portfolio that performed best during the previous calendar year resulted in annual losses of more than 17% per year. Not just underperformance, mind you, but actual losses.

In looking at mutual fund performance, the numbers get a little better but are still remarkably bad. In a study done by Vanguard, a strategy of buying the top-performing large blend mutual funds over a rolling three-year period underperformed a naive buy-and-hold strategy by 34%. And while the numbers varied slightly across mutual fund market caps and styles (small-cap value, mid-cap growth, etc.), a naive buy-and-hold approach outperforms across all. Though we see these words so often we become blind to them, experience proves them true: “Past performance is no guarantee of future results.” To be more accurate, the data here more or less guarantees that past performance is a guarantee of future results…it just so happens that the future performance in question turns out to be terrible.

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Michele Kalker 5 years ago Member's comment

But how would I get my button pushing fix? :-) Seriously though, nice article!