The Investor Behavior Penalty

How important is picking the right investment to your success as an investor? This study shows that it is what you do with your investment choices that really matters.

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Each year Dalbar, Inc. conducts a study called the “Quantitative Analysis of Investment Behavior,” which compares the returns of the average stock mutual fund to the average returns of investors in those same funds. You might think that the returns would be close to the same, but there is a huge difference. The average stock fund return for the last 20 years ending December 31, 2010 averaged a 9.14% return. The Average Stock Fund Investor Return, which is the average return that an individual investor of the same funds, was only 3.83% for the same time frame.

Why? The 5.31% difference is the investor behavior penalty, which is mostly caused by psychological factors causing people to buy and sell funds at the wrong time. Investors could have made an average of 5.31% per year in improved returns just by holding the funds that they were in. Instead, the evidence shows that they moved out of equities during down markets and moved back in when conditions improved. Instead of buying low and selling high, they did just the opposite.

This discrepancy was not only in this year’s study, but the results have been similar each of the last 17 years. What should that tell you? Don’t let your emotions drive your investment decisions, and stay invested! You cannot time the market, and you risk losing more than half of your return trying. Buy and hold is the best strategy for the average investor.

Any time you are thinking about making an investment decision, step back and think about why you are doing it. If fear or greed are driving your decisions, talk to someone who is not emotionally involved with your money to get a second opinion. Imagine if your money had grown by another 5% each year.

Graph comparing average returns

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