Why is Investor Behavior So Important?
Perhaps the most important ingredients to long-term financial security are the decision-making abilities and behavior of the investor.
DALBAR, Inc., a company that provides standards, research, and ratings for those in the financial industries, published a report in 2008 that shows the effect of investor behavior on financial investments. According to that study, the S&P 500 earned an annualized return of 11.81% during the 20 years ending in December 2007, which was a period of strong bullish markets, while the average equity investor only earned 4.48%.
Despite the opportunities, in other words, the average investor earned only 38% of the available return as a result of making poor decisions throughout the twenty year period.
To better understand the practical implications of these numbers, consider the following: assume an investor had put $100,000 into an S&P 500 mutual fund in 1988 and earned its average return of 11% between then and 2007. Even after the bursting of the 2000 - 2002 Tech Bubble, the value of that investment would have grown to $806,231. Hampered by flawed decision-making abilities, however, the average investor actually achieved a 4.48% return during the same period. That hypothetical investment of $100,000 would only have grown to $240,249. The behavior of our hypothetical average investor ended up costing him a difference of over $560,000. This is a loss of 69% of the available return of $806,231.
Unfortunately, most investors fall prey to a thought process that prevents them from always making logical decisions instead of decisions based more on emotional responses. The consequences may mean the difference between retiring with financial security, peace, and confidence and the alternative of retiring in what would feel like relative poverty.
James E. Wilson, CFP®
This is the introduction to a seven part series on Barriers to Financial Security. To download a copy of the full white paper, please click here.
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