Huge lineups of shoppers looking for deals on Black Friday and the massive retail sales that occur the weeks after Christmas are testimony to the ability of people to shop wisely. I know many families that defer buying expensive gifts (for their kids but especially for themselves) until after the Christmas holiday in order to save hundreds of dollars. So why are people so bad at investing their money?
A recent study by Blackrock, the largest money management firm in the world, confirmed what all of us know already: The average investor sucks at investing. Despite the fact that the skills and emotional fortitude necessary for successful shopping are pretty much applicable to the task of investing one’s money, it seems the average person just won’t use these abilities when making important investment decisions.
According the the American Research Group Inc., the average shopper plans to spend $854 on gifts this year. Let’s assume it will be the same next year and the next. Virtually everyone realizes that since they’ll be spending the money anyway, shopping smartly and getting all gifts at perhaps a 20% lower price leaves them better off. Wealthier in our example by more than $500 after three shopping seasons in fact!
But when it comes to buying investments, investors prefer to pay a premium. What proof do I have? Many years of observation, but the results speak for themselves.
The average investor managed to earn less than virtually all asset classes at his disposal earned over ten years according to the Blackrock study. To be perfectly honest, I’m surprised the average investor did so well.
I’m not sure about how the study was conducted. If everyone that participated had a home and kept all their money in a checking account….the result wouldn’t be very surprising would it? Let’s assume that the sample was comprised of real “investors.” Some with homes and minimal savings, but others actively investing serious money in both bonds and stocks. Where would they be going wrong?
It’s hard to imagine retail investors trading aggressively in the bond market, but assuredly a significant amount of their long term savings could include fixed income securities. It’s equally difficult to conceive that the lion’s share of their savings might be in gold or oil. Likely, the average investor does include stocks in his retirement savings and participates actively in decisions. He/she would either use an adviser to implement asset allocation decisions or occasionally channel money into or out of funds.
Consider one proxy for stocks, the S&P 500 Index over roughly the same time frame as the study. It’s certainly been a rollercoaster, but a simple buy and hold strategy would have contributed nicely to the average investor’s nestegg. In my opinion the only way the average investor could have done so poorly is by losing money making poor investment calls along the way.
Generally, folks wait until the stock market has climbed quite a long way upward before committing their own money – see the “Buy” indicators on the graph? This decision is made based on the past performance charts and tables that are promoted ad nauseum by the investment industry when the rates of return earned by their funds have been excellent.
Even though past performance means nothing, for some reason impressive historical returns awaken the greed in all of us, just like an extremely large lottery jackpot suddenly inspires many more people to go out and buy lottery tickets.
Unfortunately, great historical performance is very often followed by lousy market environments – evidenced clearly by the graph of the S&P 500 Index over the ten year period. As anxious as people are are to pile into a market that has been rewarding (after-the-fact), they are just as eager to get out of a losing situation that leaves them feeling they’ve been suckered. The average investor sells at the worst possible time. A few of these buy high/sell low episondes is sufficient to reduce the overall return he/she has earned in other assets like bonds or the family home.
Put another way, the shopper in you is always on the lookout for discounts while the investor is more than happy to pay a premium to the list price. Greediness completely overides any bargain-hunting intuition.
Back to our shopping example. Imagine that you can shop wisely and get gifts at prices 20% below list. But also imagine that you and your family can use those gifts for a time and then sell them at a 20% premium to list. Crazy? You can actually do this with your investment portfolio. Apply those shopping skills to your savings and you’ll be surprised how much better off you can be.