Smart People, Dumb Portfolios
By Gary Silverman, CFP®
Welcome to the 6th installment of our exploration of smart people doing dumb things with their investments. We’ve been tracing the alternating euphoria and panic resulting from the tech bubble of the late ‘90s.
Last week we discussed how folks made it through the recovery from the tech bubble burst. Eventually this attracted the attention of those who were not in the market 2000-2002. Next it interested those who were in, but who were diversified with little of their investments in tech. Finally it started to soothe the calloused souls of some who plummeted when the bubble burst. Yes, even some of them came back into the market.
Then came 2008 and the financial crisis; it was the greatest bear market since the great depression. But this time the dumb actions didn’t come from stock investors. Rather it was in the housing market. If you’ve seen or read The Big Short, you’ve seen how folks were taken in with the idea that the housing market would continue to go up. People were being swindled into getting in cheap with promises of getting out rich, and the largest financial institutions in the world got caught up in their own successes.
If you’ve been following along, you’ll see that there is a tendency for people to be enticed to double-down when a market is soaring and yank what’s left of their cash out after the market has taken a plunge.
This is not anecdotal. I looked at the Vanguard S&P 500 Index fund (investor class). This is an all-stock fund that follows the venerable S&P 500 stock index. It’s about as plain-vanilla a stock mutual fund as you can get. Over the last 15 years ending in June, the fund has averaged a total return of 5.63%. Morningstar, an investment research company, has compiled not just fund returns but also Investor Returns; they measure what the average investor saw in the way of returns.
If my hypothesis is right and the average investor gets greedy and tends to buy when the fund is already going up and then panics and sells after the fund has already gone down, we’d expect to see the average investor in that fund get a worse return than the fund itself.
So how did the Investor Return stack up to the fund’s actual return of 5.63%? Not so well: Investor Return over the same period was a pitiful 3.51%. To give you an idea what a difference this can make, consider a $10,000 investment made 15 years ago. At 5.63% that would have grown to just over $22,700 based on the fund’s return. But at the investor return of 3.51% the account would have been just shy of $16,800. Since I imagine a lot of the fund’s investors did nothing—just staying in and riding the fund up and down—it means that those who attempted to get in and out on their predictions of the future did even more dismally than these numbers show.
So when I say that the average investor is a pretty bad investor, I have proof.
Next week we’ll wrap up this series by reviewing what we’ve learned and how you can apply it to your own investing life.
This article was published in the Wichita Falls Times Record News on October 2, 2016.