DIY Investors Underperform the Market: Here are 6 Reasons Why
Other than a few media spiced stories about normal joe investor making millions on a trade, the majority of retail investors’ returns are just average. Actually, they are less than average. Every once in awhile we hear about the little investor making it big – like the recent Kitty Cat that made millions on Gamestop (GME). But there have been a number of studies that highlight how retail do-it-yourself (DIY) investors consistently underperform the market.
Many DIY Investors have taken to managing their own portfolios either because of what was perceived as poor performance from their previous money manager, a mistrust of ‘financial advisors’ – which oftentimes includes commission-paid salesman that are allowed to call themselves advisors thanks to the efforts of several lobbying groups, -or they may feel smart enough AND have enough time on their hands to manage their own money better than anyone else could. The data confirms that they can’t!
One of the most well-known studies on investor behavior and performance is conducted by Dalbar in their Qualitative Analysis of Investor Behavior, which is completed annually. Dalbar uses data from the Investment Company Institute, Standard & Poors, Bloomberg Barclays Indices, and proprietary sources to compare mutual fund investor returns to an appropriate set of benchmarks. The ‘average investor’ is defined by the behavior evident in mutual fund sales, redemptions, and exchanges. It does not apply to investors that buy individual securities as this activity would be much harder to measure – although I suspect the results would be similar, if not worse.
The chart below shows retail investor performance relative to the S&P 500. It doesn’t matter what period we analyze, the results are the same – average investors have underperformed a buy and hold S&P 500 strategy – sometimes by a considerable margin. So much for not wanting to pay an advisor a fee for their services. With an annualized underperformance of more than 5%, some average investors are better off being less active – or hiring an advisor.
Source: Real Investment Advice
There could be many reasons why the average retail investor underperforms a simple buy-and-hold strategy, but I will focus on just a few that I come across with uncomfortable regularity.