Do you make investment decisions according to what looks good at the moment? These purchases are often based on opinion and influenced by emotion. It can be exciting – much like buying lottery tickets.
Clearly, following a predetermined, diversified, well-thought-out, long-term investment strategy is preferable. Here’s why.
Dalbar’s study[1] of investor behavior shows how investor returns can be significantly lower than the returns of the mutual funds in which they were invested. How could this be?
From 1989 to 2008, the average U.S. equity mutual fund earned a yearly return of 5.50 percent, while the average investor in those U.S. equity mutual funds earned a mere 1.87 percent per year. Investors sabotaged themselves by trading too often or at the wrong time.
It’s no surprise that holding periods are in decline. It is estimated that investors held on to a mutual fund for an average of 2.9 years in 2000, down from 5.5 years in 1996[2]. Stock holding periods are also shortening. Investors held stocks an average of eight years in the 1950s[3] and five to six years in the 1970s[4]. By the late 2000s, the average holding period had dropped to 11 months[5].
What would explain the difference between the market return of 8.4 percent and the 5.5 percent return produced by the average U.S. Equity fund over the past 20 years? This almost 3 percent underperformance would be largely attributed to the higher fees of mutual funds.
Here’s the kicker. Over the same time period, the S&P 500 Index earned 8.4 percent per year. An investor who simply bought the S&P 500 market index fund coupled with a disciplined investment plan trounced the average mutual fund manager and his or her undisciplined followers.
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Thanks to Chris Turnbull of The Index House for providing much of this content.
The Index House is a division of Polaris Financial Inc.
