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When it comes to their portfolio, investors might just be their own worst enemy. Of course they’re not intentionally sabotaging their success, but the evidence shows it’s still happening.
In 2017, the stock markets seemed indestructible, and many investors felt that way as money poured into equities. Morningstar Direct collects data showing which asset classes and managers that money flowed to, and the timing of these money movements. These flows are a great indication of how investors are getting aggressive or being cautious and, unfortunately, how they often time it wrong.
One way to measure the impact of chasing returns is by examining a fund’s return vs. the investor return. Examining a mutual fund, it’s incredible to see that the fund can have a certain rate of return over its lifetime, but because investors cash out after things have done poorly, or put money in when they feel things are better, the average investor return is actually lower.
For example, according to Morningstar, as of April 2018 the 15-year annualized return for The American Funds Growth Fund of America (GFAFX), was 10.71%. However the investor return was nearly half that at 5.68%.
Vanguard’s Emerging Markets stock index fund (VEMIX) had a 15-year annual return of 11.75% as of April 2018, but again investors saw much lower returns of 6.98%.
It is because of the investor’s behavior that they perform so much worse. And psychologically people don’t want to remember or admit that they made mistakes of getting more aggressive when things were good, or panicking when times were tough. It’s important to realize that an investors’ own worst enemy can be themselves.
What can I do to fix this?
There are a number of things that a savvy investor can do to prevent their fear and greed from sabotaging their success.
- Passive Management: The risk of human error is why many people are choosing more passive management than active, not only because it’s less expensive, but it’s unlikely that in a year or two an index fund would far underperform their index. What’s called tracking error is reduced or almost eliminated.
- Be like Warren Buffet: Try and act the opposite of what your instincts might be. When things are euphoric, think about paring back stocks, and when everyone is freaking out be like Warren Buffet- buy low.
- Automatically rebalance: In your retirement plan, set up automatic rebalancing. What that does is, when stocks do well, it pares them back, and when they’re low it invests more. And ask your advisor to show you your asset allocation over time, just to see if they’re been making those kind of moves.
If you’re trusting your gut, you might be preventing your own success. Keeping a balanced portfolio, with the right level of risk for you, is your best bet when it comes to being a successful investor. Don’t panic when the market looks bad, and don’t get too excited when it’s looking good.