Does Investor Behavior Have the Biggest Impact on Portfolio Returns?
Back in the days of the dot.com boom, everyone wanted to be a trader. Why not? The market was going up almost every day and all you had to do was buy the latest dot.com stock and hang on. It was easy. People with no experience in finance or the markets were quitting their day jobs to pursue the quick riches and easy life of a day trader. The brokerages told us it was easy and the market seemed to prove that out.
Then something truly amazing happened. The market bubble, as all bubbles eventually do, burst. With it went the hopes, dreams, and bank accounts of the day traders. These new traders, who actually knew very little about trading, couldn’t hack the emotions of trading for a living when things got difficult. Trading is hard guys.
While the era of the day trader may be over (for now), many of us are managing our assets with the same do-it-yourself, day trader mentality. With all the information available there’s no reason we can’t outsmart the markets. Right?
What separates the pro from the do-it-yourselfer is how they deal with emotions. Professional traders are profitable because they relentlessly follow a plan which takes the emotional ups and downs of profit and loss out of the picture. This is not the case for the average investor.
According to the 2014 Quantitative Analysis of Investor Behavior published by DALBAR, emotions, which cause investors to do the wrong things at the wrong times, have caused the average investor to under-perform the long-term results of the markets.
…we have learned that the greatest losses occur after a market decline. Investors tend to sell after experiencing a paper loss and start investing only after the markets have recovered their value. The devastating result of this behavior is participating in the downside while being out of the market during the rise.
Simply put, craziness in the market brings on emotions that result in irrational investment decisions. Irrational decisions rarely give good results.
As individuals we get too caught up in the market. We wrongly think that by making short term decisions, many irrational, that we can outperform the market. Silly rabbit! Instead of just measuring our performance against the market we should instead focus on how our portfolio and financial products are performing against our financial goals. Financial decisions can then be made without the emotions that come from reacting to day-to-day market gyrations and the prognostications of the financial media.
After all, isn’t achieving our financial goals what’s really important?
David J. Seibel is founder and Managing Partner of AGS Aurora Financial Services LLC (www.agsaurora.com), an independent financial advisory firm in Matawan, New Jersey. You may contact him by email at firstname.lastname@example.org.