Wednesday, June 18, 2014

What Retirement Savers and Individual Investors Need to Know ... How to Avoid the "Investor Gap" and Achieve Superior Investment Returns the Easy Way

It doesn't sound right to most people, but it's true. When individuals invest, it is actually very easy for go-it-alone individuals to beat by a wide margin the performance of the typical individual investor who is being "aided" by stock brokers and other so-called professional stock pickers.

The reason is simple --- the 'expert' aid never comes cheap and it generally doesn't help performance returns either.

To achieve the top tier of investment returns over time, we don't need to be experts. We simply need to know ourselves. In sum, all the knowledge required for exceptional returns is to know how most people play the investing game, and then play our own different game instead.

And that's due to two simple facts --- the rule of 72 (principal is twice as high in 18 years if annual average investment return is 4% greater -- 18 X 4 = 72), and don't react to short term market volatility by trading that volatility. In simple terms, the overall general market returns will double our hard earned money over time compared to what most experts will achieve.

7 reasons why you made less than the market should be required reading for anyone with a 401(k) or related investment vehicle:

"Each year, Dalbar publishes the Quantitative Analysis of Investor Behavior. This study analyzes mutual fund inflows and outflows to determine investor returns and compares them to benchmark indexes.

The 2014 study covers the 20-year period from Jan. 1, 1994 through Dec. 31, 2013. During these two decades, the Standard & Poor’s 500 Index yielded an average annualized return of 9.2% while the average domestic stock fund investor earned a 5% average annualized return.

This 4.2% shortfall is called the “investor gap.”

The investor gap was 6.9% last year. Most stock investors, delighted with their 25.5% average return in 2013 were blissfully unaware of the magnitude of their underperformance.

Here are some self-induced causes of the investor gap:
Investors are unskilled

Dalbar insists that attempts to correct poor investor behavior through education have failed: "The belief that investors will make prudent decisions after education and disclosure has been totally discredited."       

In other words, investors are financially illiterate and unaware of the long-term consequences of their emotionally driven, short-term investment decisions....                                       

Portfolio peeking

Studies of investor behavior show that the more you look at your portfolio, the more you’ll trade.... investors who traded the most experienced the lowest returns. . . . The more you trade, the more Wall Street makes — which is why there are stockbrokers in every village, hamlet and town in America.                                        

Having no plan . . . . 

Good financial planning requires an understanding of capital markets, tax law, employee benefits, insurance and estate planning. Most people lack the time or interest to study these subjects and don't know how to create a financial plan. There's no shame in asking for help. Before accepting investment advice from a financial professional, demand a written financial plan that incorporates your income, expenses, goals, time horizon and risk tolerance.                                        

Performance chasing

Investors are repeatedly told that past performance is no guarantee of future returns . Unfortunately, most investors (and their advisers) disregard this warning under the naive assumption that they can find tomorrow's winners by analyzing past performance.

Most will soon find themselves learning a new lesson in reversion to the mean.


Many investors with whom I speak express firm opinions about what the stock market, a particular stock or the economy will do in the near future. I wish I could be so confident.                                         

A study of investors published in Why Inexperienced Investors Do Not Learn: They Do Not Know Their Past Portfolio Performance revealed that 70% of investors judged themselves to possess above average investing skill and overestimated their portfolios' past returns. The study concluded that most individual investors are incompetent and overconfident — a dangerous combination, to say the least.

Portfolio dissecting

Your portfolio is the sum of its parts. Don't micromanage it by obsessing over the recent performance of each holding. A well-diversified portfolio will always have assets that have recently underperformed expectations. Use periodic rebalancing to reinvest in its underperforming components.


The Dalbar report notes that the average investor holds a stock fund for just over four years: ”At no point in time have average investors remained invested for sufficiently long periods to derive the benefit of the investment markets.”       

Investor behavior creates the investor gap. Studies of investor behavior reveal that our instincts lead us astray — we trade too much, make poor market timing decisions and are seduced by strategies and products that promise market beating returns. What investors needed these past 20 years, and will need in the years ahead, is prudent advice about how to receive market equaling returns – not speculative advice on how to beat the market.                                        

Is your financial adviser following Dalbar's advice and focusing on planning, diversification and maintaining a long-term perspective? Or do conversations with your adviser focus on short-term performance, new investment products and market predictions? One process will minimize the investor gap; the other will perpetuate it. You are forewarned. The choice is yours."

Summing Up

It's our money and our future financial security that are on the line when we save and invest.

So let's be smart long term investors.

And by all means, let's get a plan.

As an important part of that plan, let's only incur reasonable fees to develop and maintain a long term plan and monitoring vehicle, and let's not pay people to do what we can do better ourselves.

That's how we'll make sure we achieve solid long term investment results.

Because that's what matters.

That's my take.

Thanks. Bob.

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