There are two primary drivers of investment performance: 1) the percentage of your investment portfolio that is allocated toward stocks, and 2) investor behavior.
Why Stocks?
The percentage of you portfolio that is invested in stocks matters because equity investors get paid to take on the higher risk, or uncertainty, of stock investing. We call this the equity premium and it basically means that historically stocks win from a performance perspective.
Why Investor Behavior?
Investor behavior matters because investor performance has historically been waaaaaaayyyyyyyyy different than investment performance. For example, Dalbar, a Massachusetts research firm, calculates the difference between investor returns (the return the average individual investor in a mutual fund receives) and investment returns (the actual return of the underlying investment). Their research confirms the anecdotal evidence: we (i.e. humans) suck at investing. We panic, we get greedy, we buy high and sell low, and we fall victim to a whole host of other behavioral biases.
Here’s the amount, in percentage terms, the average investor trailed actual stock market returns annually, according to Dalbar (Source: NY Times):
- 5.88%, annualized, over 30 years
- 3.46%, annualized, over 10 years
- 4.35%, annualized, over 5 years
Frankly, we just aren't wired to make consistently good investment decisions.
The Coffee, Sweaters, And Finance Team Breaks It Down For You!
In this episode of Coffee, Sweaters, and Finance, Morgan Ranstrom, CFA, CFP® and Bill Mulvahill, CFP®, CPA, fee-only financial planners and fiduciaries at Trailhead Planners, discuss the two primary drivers of investment performance and more!
- How active should I be with my investment portfolio?
- What's the role of stocks in my investment portfolio?
- Bonds have less volatility, can I just own them and skip the volatility of the stock market?
- Why is staying the course so important to long-term investment success?
- What's the difference between investment returns and investor returns?
- ...and more!!
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