Analyzing the Disparity
Part of the difference in returns between the S&P 500 index and the average investor is due to the fees and expenses associated with mutual funds. But these only account for a small part of the annual 8% disparity in returns. The major reason individual investors on average typically underperform in the market is simple: fear and greed. A common Wall Street saying is “Buy low and sell high”. But the average investor does the opposite, buying high and selling low.
During bull markets, when stocks keep going up and it seems easy to make a good return, people flock to equities — and buy high. Then when the inevitable bear market occurs, investors ride the market down until they can no longer stand the pain and they sell — low.
In his October 17, 2008 New York Times opinion piece, “Buy American. I Am”, when talking about the results of investing during the twentieth century, Warren Buffett stated, “You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.”
This sort of investor behavior is in evidence today. Just as the stock market tends to go to excessive levels during bull markets, it often declines excessively in bear markets. During bear markets, like the one we are experiencing now, people will often abandon investments when they may be better off holding on, or even making additional investments into sound long-term investments. Buying in today’s stock market climate is what it feels like to buy low.
Checks and Balances
How can you avoid this investment error that costs the average investor so dearly? Our practice is that we follow the “12 Immutable Laws of Investing”, a number of which are designed to overcome the emotional mistakes so common in investing. Do that, and your own decision making will leave you feeling less like you are caught between a bear and a bull on a rock in a hard place.
**TDIC provides various informed consent forms in English, Spanish, simplified and traditional Chinese, Korean, and Russian. Dentists can access these forms through the Risk Management section of thedentists.com.
*Jaime Davenport is a risk management analyst for TDIC, Sacramento, California.