If your New Year’s resolution is to beat the market, good luck…
While the S&P 500 Index has averaged an annual return of about 10% since 1926, most investors have underperformed – and by a wide margin.
If you add a few key steps to your investing practices, beating the market is still achievable.
Today, we’ll look at some of the biggest barriers to outperformance… and how to get past them.
According to Massachusetts research firm Dalbar, the average mutual-fund investor has done much worse than the markets for both stocks and bonds.
The numbers especially don’t look good for stock investors…
Over the past 30 years, stock mutual-fund investors have underperformed the S&P 500 by 5.9 percentage points a year.
Over the past decade, they underperformed by 3.4 percentage points a year. That’s a lot of money that folks have been missing out on.
The average bond investor hasn’t done much better. Most don’t even keep up with inflation.
You can see the underperformance for both groups in the chart below…
If the everyday investor can’t do better than the market, what’s the point of even trying? Why not just park your cash in an S&P 500 fund and earn 10% over the long term?
If you think you can stick to a hands-off investing style, this might be a good idea. As famed economist Gene Fama Jr. once said, “Your money is like a bar of soap. The more you handle it, the less you’ll have.”
But you’ll have to truly be hands-off… because while 10% is the average annual return, the returns in any given year are far from average.
Between 1926 and 2014, the average return for the market was between 8% and 12% only six times. The rest of the time, the returns were either much higher or much lower.
Volatility, as we know, is king.
So if you become an index fund investor, you’ll have to go through years of exhilarating highs and some soul-sucking lows. Most of us don’t have the stomach for that. That rules out buying and holding an index fund for a lot of investors.
If you do choose to invest and handle your own money, you need to believe this… While beating the market is difficult, it is possible.
Think about why most folks underperform…
A lot of it has to do with decisions of when to buy and sell. We tend to buy at tops and sell at bottoms. Even though most everyone understands not to do this, they just can’t resist.
That’s due to our emotions.
It’s scary to hold on to a stock that has fallen 20%. And it’s difficult to think that a stock that just jumped 30% can go higher. Emotions have a lot of influence over our decisions. Especially when it comes to money.
Diversification is a big factor as well. Many investors load into one specific sector and get crushed if there’s a downturn.
Others hold too many long positions and don’t have the necessary hedges in place if things go the other way.
That’s why it’s important to allocate your positions wisely. Spread your money across sectors, and never put all your eggs in one basket. If you’re properly hedged, you’ll find that fear has less control over your decision-making.
Lastly, no more buying at the top and selling at the bottom. Know when you’ll sell every investment you hold. If your goal is to beat the market, you want to cut your losers short… and let your winners ride.
There’s a lot to consider when you’re in charge of your own portfolio. History says you likely won’t do better than the market… but with the right tools in place, I’m willing to bet you can.
Here’s to our health, wealth, and a great retirement,
— Dr. David Eifrig
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Source: Daily Wealth