According to Dalbar, the average equity investor earned an annual return of 7.13% from 1992 through 2021, while the S&P 500 returned 10.65% and small company stocks returned 11.67%. This disparity can translate to hundreds of thousands or even millions of dollars difference between the market and an actual investor’s portfolio.
Why do individual investors do so poorly? Mainly because of fear, greed and a lack of understanding of the history of the stock market. Add in expensive investments and the odds are significantly stacked against the average investor.
Human behavior leads too many investors to jump into “hot” investments or markets (after they do well) only to ride them down while searching or waiting for the next hot investment. Emotional decision making does not go well with investing.
Although creating a sensible investment plan and sticking with it sounds boring, it has proven to work over and over again.
Time is on Your Side
Don’t just take it from the Rolling Stones; time has rewarded patient investors for decades. The compounding effects of market returns can be astonishing. The graph below shows the growth of one dollar from 1926 to 2023. Investing $100 dollars in a basket of large company stocks in 1926 would be worth over $1.4 million at the end of 2023. The more volatile small company stocks would have returned almost $3.4 million during this period. That is the effect of compound interest and time. Not too bad!
Source: Dimensional Fund Advisors
Investors don’t need to wait this long to build a fortune. As we explained in How to Become a Millionaire, it is much easier to build a large nest egg than most people think.
Patience is a Virtue
The definition of virtue is “behavior showing high moral standards.” I’m not sure that is a perfect fit here, but patience does show high emotional intelligence when it comes to investing.
Too often investors look at short time periods of underwhelming market performance and project that into the future. What they should do instead is look back at other time periods following when markets didn’t perform well. What they would learn is that the markets have come back - every time.
Source: Dimensional Fund Advisors
If we view historical market returns on an annual basis, it also shows the importance of being patient. The graph below illustrates the return every year back to 1926 with the return band of +8.0% to +12.0% highlighted. As you can see, the market rarely falls within this band. Investors should expect wide swings in returns and often negative years are followed by strong positive years.
Source: Dimensional Fund Advisors
How to Invest
There is only one good way to capture the market returns shown above and that is to own the market and stay invested through thick and thin. The best way to own the market is with passively managed index funds. We wrote about these funds here: “The Active vs. Passive Debate” blog post.
If you listen to salespeople, advertisements, your brother-in-law, or Tik Tok, you can go crazy with countless investment “opportunities.” Many of those options come with get-rich-quick dreams—don’t believe them.
What Not to Invest In
Pretty much anything that isn’t passively managed or an index fund and invested in marketable securities should be given serious scrutiny. Directly investing in real estate takes a mix of luck and skill to be successful. Insurance products like annuities are usually complex and costly with the advantage significantly skewed toward the insurance company and selling agent. Actively managed mutual funds have shown to significantly trail the passive options. Crypto still has too much uncertainty. Private equity is expensive and lacks liquidity and transparency. Individual stocks carry much more risk than a fund. The list goes on and on. We wrote about hot stock tips and investment fads here.
Taking it to the Next Level
Yes, there are many things above and beyond time, patience, and index funds that can help improve lifetime net worth. Tax planning, fine-tuning the choice of funds, estate planning, charitable giving strategies, optimizing Social Security, and risk management to name a few can all add value to someone’s overall wealth. We’ve addressed many of these in prior blogs including Financial Planning 101, Financial Planning 201, and Where Should You Invest Your Hard-Earned Dollars?
The bottom line is that investors should have a basic understanding of the history of investing, have patience, and know when it is time to seek help from a qualified advisor. Please feel free to reach out to anyone at Grand Capital Advisors with questions, concerns or clarification. Thanks, and happy investing!
