“Investing is the intersection of economics and psychology” Seth Klarman

As stated in a previous article we sent out (https://www.thebalance.com/why-average-investors-earn-below-average-market-returns-2388519):  “For the twenty years ending 12/31/2015, the S&P 500 Index averaged 9.85% a year. A pretty attractive historical return. The average equity fund investor earned a market return of only 5.19%.”

So the question is why does the average equity investor meaningfully underperform the broad equity market?  It boils down to the investor’s behavior which can be further reduced to having an undisciplined and, ultimately, emotional approach to the very unemotional Mr. Market.  The undisciplined investor many times has a risk allocation that is not properly aligned with his/her goals.  Thus, once the market hits some volatility, it is only then that many truly find out their risk tolerance often by way of a thought along the lines of “I can’t afford to lose any more.”  In a well-structured plan, expectations should be set as to how the portfolio will handle various circumstances to prevent the aforementioned painful epiphany.  So in this case, maybe a good chunk of equity investors really should not be equity investors.  The inappropriate allocation is only exacerbated by the second point:  emotional responses.  Emotions loom large in the world of investing.  For instance, say you had an appropriate risk allocation but the market continues to move up and you think of all the ways you could spend the extra money that you would have made.  After a while, as the market continues to ascend, you think,” I am tired of not making as much as I can, I will increase my stock exposure.”  This tends to happen at the worst possible time.  What follows is selling of stocks at a lower price than purchased.  Then the market goes back up. Rinse.  Repeat.

Have a plan and stick to it.  Some people are certainly capable of doing it on their own but for the average investor the data disagrees.

By Kyle Gowen, CFA, CFP® | Director of Investments

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