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Library Home Street Smart Report Home
BEING STREET SMART
by Sy Harding
Why Do Investors Under-Perform? November, 1999.
As a group, individual investors apparently do far worse than professionals, far worse than the market average. The National Association of Investment Clubs reports that investment club members scored an average annual return of 12.4% for the ten years from 1988 through 1998. The average annual return of the S&P 500 was fully 50% better at 19.2%.
It might be helpful if we could discover why that is. What do individual investors do that's so different from the professionals they're competing against?
It would seem that near the top of the list might be that professionals have a specific investment style, including both an entry and exit plan (to take their profits) that they pretty well stick with.
Meanwhile, most individuals seem to have no strategy or plan at all. One week they buy Qxxxxy because they happen to catch a brokerage firm spokesman saying that although the stock was up 1000% in 1999 and selling at 200 times earnings, it should move still higher (momentum investing). The next week they read a magazine columnist who likes Xyyyy because it's down 50%, selling at a low price/earnings ratio and below its book value (value investing), and that sounds good. The following week they read a book about the strategy of buying "the dogs of the Dow", so they buy some of those. There is always something that makes the grass look greener on the other side of the street.
They subscribe to four newsletters, each with a different investment strategy, and try to follow parts of all four, then spend hours watching financial TV, taking tips from a parade of mutual fund managers, each successfully following their own strategy, but touting a different strategy and holdings than that of the previous guest, or the one that comes after.
They surf the investment websites picking up tips, usually totally un-related, here and there, and even tune in to chat rooms to see what tips other individual investors have picked up and are passing along.
If it can even be remembered which strategy seemed attractive when each stock was purchased, it would still require juggling numerous different strategies to manage the portfolio through various market conditions. Professionals, working at it full time, seem to find it challenging enough to manage one strategy.
A second problem seems to be in the area of an exit plan or time horizon.
Ask most investors what their time horizon or exit plan is and they'll say they're buy and hold investors, in for the long haul, ready to hold through whatever comes along.
But look at their portfolios and you'll find that every stock they ever owned they sold when it disappointed them by declining. Every market they were ever in they sold out of when it surprised them with a big decline. Japan, Asia, Mexico, Latin America, (the U.S. in 1987 and 1990). Every high-flying sector they were ever in was sold when it shocked them by being just as cyclical as any other. Technology (several times), biotech, airlines, casinos, entertainment, healthcare, etc.
Every investment style they ever adopted, sector funds, small cap value funds, emerging market funds, managed growth, etc. was abandoned after they under-performed for six months to a couple of years, and some other style came along.
Ask why they still consider themselves buy and hold investors even though they've never held through any declines and waited for the stock or sector or market to come back, and they'll say something like, "Well, it just went down so much I realized it wasn't something to hold. And there were other things that were doing better." (That's the way it always is with buy and hold).
There are many strategies and approaches to the market that work. Even buy and hold works in theory (if one could actually hold through the pain, then wait for the market to come back, and if one could know that his or her specific holdings would come back when the indexes that 'prove' the theory come back).
But a hodge-podge of numerous strategies is actually a lack of a strategy. It, coupled with a lack of risk management, is only liable to work in a rising market. We suspect that's the biggest reason why individual investors are beating the professionals and mutual funds over the last year or two, while significantly under-performing them over the last 10 years.
