Tuesday, November 15, 2011

Investment vs Investor Returns

The stock market has been quite volatile lately. We’ve seen many days of big swings in both directions. The past quarter was very negative while October provided a big positive. Every news event spreads quickly and seems to affect the market. The media doesn’t help.

Volatility scares investors. If you jump out now, when do you get back in? Once the smoke clears? What signs do you look for? Most of the time, you’ll get back in too late (or at least later than you should have). Hindsight is always 20/20. Foresight is very problematic.

Some investors try to shift from here to there. Sell your “dogs” and load up on the recent winners? It makes sense to switch to the better performing fund, right? Don’t forget the disclaimer on every investment advertisement; “Past performance does not guarantee future returns”.

Unfortunately, timing and investment shifting is how many people invest. Dalbar (a research company) conducted a study on investor behavior. They studied the twenty year period from 1990 through 2009. The average US equity mutual fund had an annualized return of 8.8%. The average investor in those mutual funds earned an annualized return of only 3.2%. Why the huge difference? Unsuccessful market timing. Investors try to time the market and/or move from one mutual fund to another based on recent returns. They usually get it wrong.

Carl Richards, CFP® (a financial planner in Salt Lake City, UT) affectionately calls this the “Behavior Gap”:We can’t control the markets. We can diversify, remain disciplined (control ourselves) and achieve what is rightfully ours: “investment returns”.