I attended a seminar recently with a group of about 25 people. We were asked to close our eyes and raise our hand if we thought that we were an above-average driver. The presenter then told us to keep our hands up and open our eyes. All but two people had their hands up!
Clearly, everyone can’t be above average, but why do we think we are? People generally know themselves better than any others and may not realize that other people are just as good.
So what does this have to do with investing? I believe that successful investors are the ones that keep their emotions in check during the highs and lows of the stock market. According to Dalbar, the average stock fund investor experiences returns that are consistently below the returns of the average stock fund.¹ This suggests that people on average underperform their own investments! Dalbar calls this the “Investor Behavior Penalty,” because people tend to get into and out of the market at the wrong times for the wrong reasons.
Here are just a few of the irrational actions by most “average” investors, according to Dalbar:
- Narrow framing: Making decisions without considering all implications
- Anchoring: Relating to familiar experiences, even when inappropriate
- Herding: Copying the behavior of others even in the face of unfavorable outcomes
- Media response: Reacting to news without reasonable examination
- Optimism: Believing that good things happen to “me” and bad things happen to “others”
As you can see, emotional decisions can lead to poor results. Consider working with a financial advisor who understands when you are likely to make a “mistake” so you can hopefully stay on the path to above-average results!
¹Source: “Quantitative Analysis of Investor Behavior, 2011,” DALBAR, Inc. www.dalbar.com