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Friday, June 19, 2015

Investors’ Alert: Are You Making These Two Mistakes?

The first time I looked at the incredible chart below, I thought of the classic book, “Winning the Loser’s Game” by Charles Ellis.

Last year, Richard Bernstein Advisors, using the research provided by Dalbar, put out a 20-year performance chart of most asset classes and compared it to the return of the “average investor.” Who are the average investors? They are individuals who buy and sell individual stocks, bonds, exchange-traded funds (ETFs) and mutual funds and are subject to all the “animal spirits” of pessimism and optimism that cause them to buy at the top and sell at the bottom. To determine how well or poorly they did, researchers at Dalbar systematically scanned mutual fund entries and exits to determine exactly when and where investors were getting into a wide allocation of assets.

It turns out that the “average investor,” as defined by Dalbar and reported by Bernstein, had a terrible batting average — about 3% a year over the past 20 years (1994-2014). The so-called average investors underperformed almost every index imaginable. Not only did they underperform the S&P 500 Index, but corporate bonds, energy, gold, emerging markets, utilities, you name it. Even investing in T-bills did better than the average investor! There was one silver lining: they outperformed Japanese stocks! But not by much.
What mistakes did the average investors make? Two critical ones: 1. They bought the wrong stocks, which underperformed the market. This became ill-fated “cherry picking.” 2. They traded stocks rather than adopting a sounder “buy and hold” strategy. Cherry picking and trading are always high-risk, but they are alluring.

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