Every year Dalbar , Inc., a financial services firm in Boston, conducts a study on the investing acumen of typical Americans. Usually, the results are appalling.
In this year’s study, which was released this week, investors fared much better than usual. In 2006, the average stock fund investor generated a return of 14.7%, while the Standard & Poor’s 500 Index, which is the benchmark for large company stocks, jumped 15.8%. Not bad at all!
Why did investors do well last year? Because they weren’t antsy. Americans were happy to hold onto their investments because they were making money. And in 2006 it would have been hard not to make a lot of money on Wall Street.
What trips up most investors is what they do when the markets start imploding. That’s when the fear factor kicks in and destroys portfolios. Scared investors flee the markets or they chase something that looks like it’s a sure money maker. People, who end up sitting on the sidelines, then agonize about when they should retrieve their cash from the savings accounts and CDs and return to the market. Of course, most often, their timing is wrong, which is why the overall stats for investors are abysmal.
If you look back 20 years, the typical stock fund investor, according to Dalbar, has captured a yearly measly return of 4.3%. In contrast, the S&P 500 Index has generated an annualized return of 11.8%.
Rather than trying to time the market, it’s best to put together a diversified portfolio that is divided among different types of investments that will perform differently in various market conditions. The variety will help reduce your risk regardless of what’s happening on Wall Street. Once you’ve done that, you only need to rebalance the portfolio once a year.
It’s also best to automatically invest through dollar cost averaging on a monthly basis so you won’t have to fret about whether this is a good month to sink money in the market or not. And when you invest during market tantrums, you will be buying mutual funds on sale.
As you ponder your own investor behavior, keep in mind this observation from the Dalbar report:
“It is easier to make the right decision when markets are rising and the fear of loss is on the back burner. The really smart decision, that most investors get wrong, is to invest when the market is down. If you don’t know when to get out, it is better to stay in.