Investors Are Still Behaving Badly

By Carl Richards, August 5, 2010, New York Times

Every year the research firm Dalbar does a study that tries to quantify the impact of investor behavior on real-life returns by comparing investors’ earnings to the average investment (using the S&P 500 as a proxy).

The latest study looks at the 20-year period that ended Dec. 31, 2009:

• Average investment return = 8.20 percent
• Average equity investor return = 3.17 percent

If you had put money into an S&P 500 index fund 20 years ago and just left it there — no buying, no selling, just investing and forgetting about it — you would have earned (minus fees) about 8 percent.

But real people don’t invest that way. We trade. We watch CNBC and listen to Jim Cramer yell. Despite knowing better, we give into the genetic tendency to get more of those things that give us pleasure — buy high — and get rid of things that cause us pain — sell low. We’re just wired that way.

What is really interesting is how little this seems to change over the years. When it comes to investing, the tendency to behave badly is not going away.

So what do we do about it?

1. Admit it. Like any destructive behavior that first step to fixing it is to admit that there is a problem in the first place. Being honest with yourself and reviewing past decisions will help:

• Did you get caught up in the tech bubble in 1999?
• Real estate in 2006?
• Did you sell in 2002, late 2007, or early 2008?

2. Develop a checklist. Then go through that checklist before you make major investment decisions. It works for pilots and doctors. It will help you avoid mistakes in investment behavior, too.

Try writing down the proposed change and then let it sit for 24 hours, or call a trusted friend or adviser and walk them through your thinking before you make the change. Often just hearing yourself explain why you want to make the change will convince you to forget the whole thing.

3. Don’t play. Sometimes the answer might be to take our money and go home. There is nothing that says you have to invest in the stock market to be considered an intelligent human being. It is fine to recognize that it might work better to follow Will Rogers’s advice and focus on the return of your money instead of the return on your money.

The reality is investing successfully is hard. But hopefully by focusing on our behavior, we can close this gap in the next 20 years.

http://bucks.blogs.nytimes.com/2010/08/05/investors-are-still-behaving-badly/?ref=your-money