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Are you an Average Investor? I Hope Not... -Article #1

What are your investment strategies? Maybe you follow some "investing guru" like Jim Cramer on CNBC. How has this fared for you? Are you beating the markets? Statistically speaking, you're not.

This chart is from one of the industry's leading independent research firms, DALBAR, highlighting the investment returns from people and from the markets.

Circled in red:

  • 30 year "Investor Returns" in Equity Funds: 3.98%

  • 30 year "Market Returns" in the S&P 500: 10.18%

That's a 6.18% per-year difference for 30 years!

Let's put that into perspective

If you saved $10,000 per year from 1986 to 2016 ($300,000 total savings):

  • "Investor Returns" balance: $558,980

  • "Market Returns" balance: $1,695,580

Why are "Investor Returns" so bad when "Market Returns" are so good?

It must be fees!?

The median all-in cost of a financial advisor serving portfolios under $250k is 1.85%, dropping to 1.75% for portfolios under $500k, 1.65% up to $1M, and 1.5% for portfolios over $1M.

[Advize Wealth Management is proud to start serving clients with portfolios under $250k at an all-in cost of 1.4%]

So... Where the hell is the other 4.33% deficit? [6.18% - 1.85%]

There are unlimited ways people manage to underperform the markets, but to summarize most of them - bad investment behavior.

The DALBAR study quotes, "Investor behavior is not simply buying and selling at the wrong time, it is the psychological traps, triggers and misconceptions that cause investors to act irrationally."

People are constantly exposed to "this year's hot stock"or "10 ways to get rich quick" schemes and therefore are constantly changing their investment holdings. The average retention rate for equity funds is only 3.5 years. So over a 30 year period, the average investor is expected to buy over 8 different products in hopes for a "winner".

Another common pitfall for investors is our own human nature. Nobel Prize winner and Princeton University Professor, Daniel Kahneman, found that we tend to feel a loss about twice as severe as we experience a gain; and therefore tend to exhibit a behavior known as loss-aversion. This fear of loss was really helpful 10,000 years ago when it meant you'd be eaten by a saber tooth tiger, but has now created terrible investors.

The loss-aversion behavior is quite obvious as the DALBAR study measures that when markets are down, large amounts of money flow OUT of equity funds; and when the markets are up, large amounts of money flow IN to equity funds. It intuitively makes sense to get out when "things" are bad and get back in when it's safe. But in reality, what is really happening is that people are buying HIGH and selling LOW, year after year.

Not me, I'm above average!

On a scale of 1 to 10 (10 being best), how are your driving skills?

Before reading this article, you'd probably say between 6-8. Optimism bias is another cognitive hurdle for investors; as we also believe that we're funnier than average, our kids are cuter than average, etc. The harsh reality is that this is simply not statistically possibly, but yet people still believe they are better than average investors.

My Sincere Advice

  1. Take the time to understand what you're investing for. Given that this article is pretty much about long term returns, let’s assume the money is for retirement or growing family wealth.

  2. Get "Market Returns". Your goal is to live a purposeful life, not beat the markets. Nobody lays on their death-bed proud of their investment returns. And besides no mutual fund, hedge fund, guru, or CFP® pro can consistently outperform the market with any level of certainty - not even Jim Cramer (Sorry Jim, we can still be friends). Period. Invest in low cost, globally diversified index funds and you will get virtually identical market returns.

  3. Work with a competent advisor. A good advisor will help you quantify your goals, make a plan, hold you accountable, measure your progress and help make adjustments along the way. Could you achieve your goals quicker and with a higher chance of success with professional help - I believe so!

So I'll ask again... Are you an average investor?

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