The Most Common Investment Mistake
On average, people are not as successful as they could be at investing. Dalbar has been documenting this reality for decades with an annual survey comparing results obtained by stock mutual fund investors with index returns.
Between Jan 1, 2001 and Dec. 31, 2020, the S&P 500 averaged 7.43% per year, while Dalbar calculates that the average stock mutual fund investor only earned 5.96%. What accounts for the nearly percent and a half deficit? By and large, investors zig when they should zag.
When the market is rising, people get excited by the profits being made and they want in. When the market is correcting, many investors become frightened and they want out. In other words, buy high, sell low.
Attempting to avoid losses is, I suspect, the #1 cause of subpar investment results. As a financial planner, I have witnessed this phenomenon again and again. When the market goes through a correction, particularly a prolonged correction, we start to hear investors say “I want to get out, I’ll get back in when things calm down..”
Translation “I want to sell now while the market is low, and I’ll get back in when it’s higher.” This is simply a manifestation of human nature. Losing money induces fear, and fear induces counterproductive investing behavior.
Another factor is the underlying false sense that we can predict what is going to happen in the market or the economy. I’ll illustrate this part of the problem with a thought experiment.
Imagine it’s January 1, 2020, and you have a crystal ball that shows COVID is coming. You can see that it will cause a near shutdown of the global economy, that unemployment will skyrocket, and large swaths of businesses will be decimated.
Seeing all of that in your crystal ball, what if you were given the option to go to cash for one year and avoid the markets entirely in 2020? Would you have taken that offer? I suspect that for most of us the answer would be “yes,” and that seems perfectly sensible. But it would have been a huge mistake!
In 2020, a year that will be remembered as terrible at epic levels, the Vanguard Group reported that the S&P 500 rose 16.3%, the Bloomberg Barclays 5-10 Year bond index was up 9.73%.
Meanwhile, according to Kiplinger, the tech-heavy Nasdaq rose an astonishing 43.6%. Oh, and the housing market was booming too, as were the prices of gold and cryptocurrencies.
So even if you knew the future with perfect clarity, you wouldn’t have known the outcome from a market perspective, which, in my nearly 30 years of experience as an advisor, is perfectly consistent with how it pretty much always works.
The year 2020 gave us yet another lesson in the fact that two concepts are paramount in successful investing.
First, we need humility. Understand that the market is unknowable, and that attempts to trade based on figuring it out most often end in bad results. And second, patience is key, because the best thing we have going for us in the stock market is its long-term upward trend.
In March of 2020 we saw one of the most dramatic sell offs in history, and yet by year-end, the market was back in record territory. With the benefit of hindsight we can see that the best thing that could have been done in March was to buy, the second best would have been to hold, and the worst would have been to sell.
But isn’t that the lesson of every correction in history?
The stock market doesn’t rise over time because of magic. The increasing value is a result of human hard work and ingenuity leading to increasing values of businesses. Investing in the market is a bet on human success.
Doing it well starts with recognizing what you do not, and cannot know: the short-term direction of the market.
Armed with that humility, the power of patience becomes clear.