By Keith Lanton
A recent DALBAR study reveals that from 1990-2010 the average investor earned a 3.49% equity profit. Over the same time period the S&P returned 7.81%. Why has the average investor underperformed the S&P by 4%? I believe the answer lies within.
Successful investors know themselves better than less successful investors. In other words, successful investors spend meaningful time reflecting on how they have reacted to events in the past. They have analyzed their prior actions, have truly thought about them and have learned from them. They have a better understanding how they will react in the future when faced with market adversity and they have incorporated that learning into the structure of their current investments.
Most investors do not think deeply about how they will react to a sudden sell off in the market, or, inversely, how excited and euphoric they will feel in a rising market. The only time most investors even superficially think about how they will react in the face of market volatility is when they are presented with a questionnaire upon the establishment of a managed account.
The answers investors provide on these surveys is what the investor believes or at least would like to believe is how they would react when faced with market volatility. Unfortunately, if investors do not truly know themselves then the answers to these questions may not be indicative of the actions they would take when encountering meaningful market movement. In all likelihood when an investor has not reflected and is encountering a volatile market it is the investors emotions that will hijack the decision making process. In other words, at this point fear greed and ego are driving the portfolio. It is at this critical moment when the decisions are made that drive underperformance.
Therefore, the key to better performance is to truly know yourself better. If you know yourself, and you realize that given market volatility you may not act in your best long term interests then you need to be smart enough to hire an advisor that truly knows you. The advisor may be able to make you aware of your emotional thinking and offer you an important second opinion before you take market action.