Why The “Average” Investor Is So Bad At Investing
It’s a sad truth, but the average investor is terrible at investing.
This isn’t just my opinion. This is what the data says. In fact, the troubling reality is that many would be better off putting their money under their mattress and allowing their purchasing power to erode with inflation.
That may sound shocking to you, but let’s take a look at the facts…
Consider a study from Dalbar, a financial services market research firm. Theyt found that in 2018, where the S&P 500 lost some 4.4%, the average investor lost 9.4%. This wasn’t a one-off year, either. Over a 30-year period, the average stock investor generated an annualized return of 4.1%, less than half of the S&P 500’s 10%.
One of the biggest factors behind such poor performance by the average investor is that emotion gets in the way. Most investors lock in gains too soon while hoping that their losers rebound. This phenomenon is called “loss aversion” in the field of behavioral economics.
In their excellent book, “Why Smart People Make Big Money Mistakes and How To Correct Them,” authors Gary Belsky and Thomas Gilovich expand on this idea in some detail. They point out that oversensitivity to losing money can also sometimes make us hold on to losing investments for longer than we should. To quote the authors:
Ask yourself if you’ve ever sold a stock not because you thought it was finished rising, but because you wanted to ‘lock in profits.’ And ask yourself how many times you’ve held on to a losing stock or mutual fund because you were sure it would ‘come back.’
The Difference Between “Average” And Great
I know I talk a lot about letting your winners run and, more important, cutting your losers short. But I can’t stress enough how important this is. And this Dalbar study proves exactly why.
If you want to be significantly better than the “average” investor, then stop doing what the average investor does. The average investor buys high, sells low, and lets small losses snowball into big losses.
It helps to have an objective system give you clear signals. Over at Maximum Profit, our system does just that… It doesn’t allow for a “wait for that stock to rebound so we can sell to break even” mentality. If a trade isn’t working out, we cut it and move on.
Take Glu Mobile (Nasdaq: GLUU), for example. I recommended the company a while back after our system flagged it as a “buy”. In May that year, the stock was showing strong momentum – momentum that quickly vanished after it reported earnings on May 6. Investors didn’t like what they heard and sold off shares. As a result, our system flashed a “sell” signal, and I sent out an alert saying that it was time to cut our losses and move on.
The sudden drop in share price meant we booked a loss of roughly 17%. Now, don’t get me wrong, I hate it when that happens. But we’ve found gains of 20%, 118%, and 266% with the Maximum Profit system. And besides, no system is perfect. So as long as my followers used proper position sizing and followed our signals, they were just fine.
And as it turned out, I’m sure glad we cut our losses when we did. Because investors who decided to wait for the stock to climb back closer to their entry pricesaw their original investment cut in half.
It’s hard to realize what a 50% loss means… and what’s required just to recoup the original investment. A 50% loss requires a 100% return just to break even. Triple-digit gainers aren’t easy to come by. But for readers who followed our “sell” signal, our 17% loss in GLUU required roughly 20% to get their money back — a much easier pill to swallow.
Action To Take
When the market throws a temper tantrum (like we saw beginning last week when the tech-heavy Nasdaq decided to give up some of its recent gains), don’t let emotions dictate your trades. Take a step back and think logically. Have stop-losses in place and rules to follow.
They don’t have to be our rules over at Maximum Profit, either. Just have some and follow them. If you get stopped out of a trade, it’s okay. You can always get back in. You can always find another opportunity.
P.S. One opportunity my colleague Dr. Stephen Leeb recently shared with me is quite shocking…
I won’t keep you in suspense: He’s recently discovered a company that’s sitting on what could be the largest gold deposit ever discovered…
Barely anyone is talking about this deposit right now… But he’s telling anybody that will listen that now is the time to get in on this pick. If he’s right, it could allow early investors to make 20-times their money… maybe more.