Nice piece by BMO Nesbitt on why investors fail:
“Individuals have historically underperformed the markets, earning just 2.6% vs. the S&P 500 gain of 12.2% between 1984 and the end of 2002*. Research in the U.S. has shown that this dramatic underperformance comes as a direct result of client behaviour, or more specifically, the attempt to avoid bad performance while seeking out better returns.“
* “Quantitative Analysis of Investor Behavior“, Dalbar Inc., July 2003
What’s the cause of this underperformance? Assuming there is an appropriate asset allocation plan in place (Diversification in styles, geography, managers, and appropriate weightings for each security), what is the dominant problem for most investors?
In a word, EMOTION.
Here’s a look at the classic cycle of investor sentiment:
Sentiment Cycles within the Market (a/k/a Investor Emotions)
click for larger graphic
Major emotional risks equity investors face include:
• Herd mentality
• Likely investment at the top (Buy High)
• Likely withdrawals at the bottom (Sell Low)
• Deviation from long-term strategy and discipline
We discussed the biology of this previously in Know Thyself.
Why Investors Fail! (pdf)