The data is conclusive. The average investor’s returns are, umm, below average. How can this be? What appears to be statistically impossible is due to two basic factors, investment discipline and costs.
Over the last 20 years, the average stock investor earned 3.49% compared to the S&P 500′s return of 7.81%. A $100,000 investment in the S&P 500 made 20 years ago would be worth $449,967.27 today, versus the value of $198,594.74 for the average equity investor.
Why does the average investor do so poorly? One reason may be that they are too quick to change investments.
Dalbar is a firm that studies investors’ behavior. According to Dalbar’s most recent study (April 2012), 3.29 years was an investor’s average holding period for an equity fund over the last 20 years. This is a very short holding period for a long-term investment. Three years is a blink of an eye in the capital market’s history and in most investors’ investment time horizons.
If your time horizon is only three years, stock investments may not be appropriate. If your investment horizon is longer than three years, I believe that your average holding period should be much longer. I think short holding periods are one of the biggest contributors to poor investment returns.
The capital markets offer returns in a random pattern (see this post on market timing). In order to earn the returns offered by the stock market, an investor has to be able to withstand the emotions that erode a long-term plan.
In my experience, a diversified, low-cost portfolio combined with a thoughtful financial plan offers defense against succumbing to emotions at the wrong time. Thus, it’s the best path to long-term investment success. Without a well-articulated investment strategy, it’s too easy to swap one investment horse for another. Broad diversification and careful rebalancing can improve the investor’s chances for success. (See this recent post on diversification for more details)
Investors who construct a portfolio purposefully rather than end up with a portfolio that’s the result of unrelated and spontaneous investment selections have a much better chance of achieving all that is important to them.