Before you invest another single dime into the stock market, read this article. In fact, I encourage you to forward this to anyone you know who invests.
For most people, hearing what I’m about to say would make a life-changing difference in the growth of their portfolios.
My message starts with this chart…
This information was compiled by the market research firm Dalbar. The chart shows the 20-year annualized rates of return of various asset classes and the S&P 500 stock market index from 1999 to 2019.
This is a unique time period because 1999 was the top of the dot-com bubble.
As a result, the 20-year annualized return for the S&P 500 was only 6.1%, considerably below the historical norm of 8% to 10%.
But I want you to zero in on the average investor’s performance…
While the overall market went up by 6.1% per year over these two decades, the average investor generated annualized returns of only 2.5%.
That is a terrible result.
Achieving a return this far below that of the overall market delayed retirement by many years for a countless number of people.
It changed the quality of retirement for many more.
The 2.5% annualized returns generated by the average investor over this period barely even surpassed the 2.2% annualized rate of inflation.
That means, in real-dollar terms, the average investor barely grew their wealth at all.
That isn’t good enough…
Human Emotions Drive Underperformance
This Dalbar study is just one of many studies that draw the same conclusion.
Last September, I wrote to you about how while Peter Lynch was driving the Fidelity Magellan Fund to astounding 29% annualized returns from 1977 to 1990, the average investor in his fund didn’t even break even.
That is brutal.
How does this happen to the average investor?
The average investor lets their emotions drive their decisions during both good and bad times.
When the stock market is booming, the average investor gets greedy.
This means the average investor is piling money into the market when stocks are most expensive and most likely to fall.
As Warren Buffett says, “You pay a very high price in the stock market for a cheery consensus.”
Then, when the stock market is falling, the average investor’s emotions swing too far the other way. Fear takes over.
A falling stock market drives the average investor to sell stocks when they are cheapest… the worst possible time to sell.
Three Simple Rules
The data doesn’t lie. Study after study shows that the average investor is their own worst enemy.
For us, that means we must not be average.
The good news is that being a better-than-average investor is actually incredibly easy.
It just takes three really simple rules…
Rule No. 1: Never Sell Stocks During a Market Crash
Just don’t do it!
History shows us that the stock market always recovers. Selling on the way down is always a mistake.
If you have a near-term need for cash, that money shouldn’t be in the stock market in the first place.
If you never sell during market turmoil, I guarantee that you will immediately be doing enough to outperform the average investor.
Rule No. 2: Treat Your Money Like a Bar of Soap
As the famed economist Eugene Fama once said, “Your money is like a bar of soap. The more you handle it, the less you’ll have.”
Put your money to work in a diversified portfolio of stocks, and then let time be your friend.
Stop trying to time the market and moving money in and out.
Rule No. 3: Trust the Overwhelming Historical Data
Print out a historical chart of the S&P 500 and paste it to the wall in front of your desk.
The trend in that chart is not subtle.
Over time, it goes up, up and up some more.
As we learned last spring, even violent stock market crashes are just minor bumps relative to the long-term upward journey of the market.
Trust the process and stay in the game.
The only hard part is managing your emotions. But if you can do that, your results will be much better than average.