Why Do Individual Investors Do Worse than the Funds They Invest in?
October 15, 2010I wrote ‘How does Drew Brees Do That?’ in a prior posting about decision making. I was reminded of that while listening to a financial talk show. The host talked about a study that was performed to track individual investor performance vs. the performance of the funds in which they invest. The study was very revealing and it ties in with the concept of decision making. The study said that over a 20 year period ending in 2005, the average stock mutual fund earned 11% while the average stock mutual fund investor earned only 3.9% during that time frame. My first question was…why?
What is happening that causes investors to do worse than the mutual funds that they buy? It’s simple, and it’s about decision making. Many investors are making decisions based on emotions rather than strategy and that hurts them when analyzing investment performance.
Here’s the situation and how it unfolds. As the stock market goes up and up and up, investors tend to hear about the positive results and want to participate in the market. So, they take cash and buy stock (often in the form of mutual funds). During the rise in the market the mutual funds have earned positive results but the investor has only participated in a portion of the upturn. They often miss a significant portion of the gains.
On the other side, when markets are heading downward, many investors tend to do nothing at first and then sell when the situation looks bleak. Often, investors experience the majority of the downturn and sell at or near “the bottom.”
The old phrase “Buy Low, Sell High” makes sense when thinking about investing. Evidence indicates that many investors make decisions that end up with them employing the not-quite-as-successful strategy of “Buy High, Sell Low….”