The above chart is hypothetical and assumes various rates of return compounded annually. It is for illustrative purposes only and is not indicative of the performance of any specific investment. Investment return and principal values will fluctuate so that your investment when redeemed may be worth more or less than its original cost.¹ Past performance is no guarantee of future results.
The annual ‘Dalbar study’ (Dalbar is an oft-cited financial research firm) consistently demonstrates how the average investor significantly underperforms ‘the market’ over the long-run.
As you can see in the image above, from 12/31/96 – 12/31/16 (about 20-yrs) with an initial investment of $100k, the average equity investor would have underperformed ‘the market’ by over $184k (2.89%/yr) and the average fixed-income (bond) investor would have underperformed ‘the bond market’ by over $170k (4.81%/yr)!
During this current period of market volatility, it is important to avoid making some of the mistakes that may lead to this underperformance. (As a reminder, all investing involves risk, including the risk of loss of principal.)
7 Common Mistakes People Make Include:
1. Trying to time the market
- When the market is volatile, it’s tempting to try and time when to buy and when to sell. However, there is a large body of evidence indicating that timing the market effectively and consistently is next to impossible, even for professionals. The large majority of the time, the best time to invest is as soon as possible and for the long-term, ignoring temporary market volatility.
2. Making emotional decisions based on news / current market events
- When the market is volatile, the financial media explodes with stories, opinions, analysis, etc. Unfortunately, all this coverage only benefits the financial media with more clicks, views, etc. which leads to more revenue for them.
- On the flip-side, many investors get caught up in this noise and make emotional decisions based on what they heard or read on CNBC. It usually starts with “I heard on CNBC that the stock market is going to drop by 5,000 points!”
- Work with a professional to help filter the noise, or avoid it altogether, to avoid making emotional decisions that may cost you money in the long-run.
3. Selling during a market decline
- Market volatility is common; in fact, a 10%+ drop happens on average about once per year. Most declines typically last anywhere from 20 trading days (the 1997 correction, down 10.8%) to 104 days (the 2002-2003 correction, down 14.7%).² The mistake many people make is assuming that if they sell during a decline, they’ll be better off. But more often they’ll sell just before the market recovers and end up much worse off than if they did nothing. Talk with a professional before making any trading decisions during a market decline.
4. Not understanding the risk in their portfolio
- Many investors make the mistake of not understanding how much risk is in their portfolio and how it compares to the ‘the market’ they hear on the media (which is typically the S&P 500 or Dow Jones indices).*
If ‘the market’ were to drop by 20%, investors should have an idea of how much their portfolio would drop in relation to this. Meaning would their portfolio drop even more than 20% due to higher risk, about the same, or significantly less than 20% due to much lower risk.
5. Not diversifying
- Market volatility is often due to market participants and traders making adjustments to their portfolios based on new information around the economy, company earnings, future expectations, politics, etc.
The investors who get hurt the most are typically not diversified appropriately. For example, during the tech bubble of the early 2000’s, many companies went completely bankrupt and the entire tech sector had massive losses. However, a diversified investor likely had much smaller losses and in fact some even saw gains during this period (if they were diversified into international and emerging markets, fixed income / bonds, US values stocks, etc.) (Diversification strategies cannot assure a profit or protect against a loss.).
6. Acting on ‘Water Cooler’ recommendations
- Market volatility causes more interest in the stock market, and therefore more ‘water cooler’ talk and recommendations.
- Suddenly people in a wide variety of professions become experts in the stock market and have ideas for the next great investment opportunity.
- A few years ago it was gold; before that it was oil; before that it was tech stocks. Trusting these ‘water cooler recommendations’ can be one of the best and fastest ways to lose your shirt.
- Understand that successful investing is a long-term game measured in years and decades, not days and months. Avoid getting impatient during a period of market volatility and instead focus on your long-term financial plan. Speak with a professional to help you create a plan if you don’t already have one.
1. Reference this page (https://www.odysseywealthdesign.com/tools/glossary)for definitions on the S&P 500 and the Dow Jones;
2. “Market Briefing: S&P 500 Bull & Bear Markets & Corrections” Yardeni Research, Inc. https://www.yardeni.com/pub/sp500corrbear.pdf Accessed April 3, 2018
Roberto J. Duran CFP®, ChFC®, CRPC® and Ross Atefi, AAMS, CRPC, CCPS are registered representatives and investment advisor representatives of Lincoln Financial Advisors Corp., a broker-dealer (member SIPC) and registered investment advisor, 18400 Von Karman Ave., Ste 550, Irvine CA 92612 offering insurance through Lincoln affiliates and other fine companies. This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances. The content of this material was provided to you by Lincoln Financial Advisors Corp. for its representatives and their clients. Insurance offered through Lincoln Marketing and Insurance Agency, LLC and Lincoln Associates Insurance Agency, Inc. and other fine companies.
Copyright 2018 Odyssey Wealth Design. Odyssey Wealth Design provides financial planning and wealth management to clients in Orange County, Irvine, Newport Beach, and around the country.