Why Do So Many Investors Self-Destruct?

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"The investor's chief problem-and even his worst enemy-is likely to be himself," once quipped the great Benjamin Graham.

The truth of Graham's observation is seen in the consistent pattern of mutual fund investors to self-destruct.

AUDIO: Portfolio Report Card:  Ron Grades a $480,000 account


Over the past 30 years, the typical stock mutual fund investor's performance has badly lagged the S&P 500 index (SNP:^GSPC), according to Dalbar's Quantitative Analysis of Investor Behavior (QAIB) report. While the average mutual fund investor earned 3.69%, the S&P 500 earned 11.11%.  What were the chief causes behind the significant undeperformance?

The underlying problem wasn't the 1987 stock market crash (NYSEARCA:DIA), the 2000-2002 dot-com bursting (Nasdaq:QQQ),  the 2008-09 financial crisis (NYSEARCA:XLF), or poor economic conditions - but rather - investor misbehavior.  People chase historical performance, buy the wrong things at the wrong time, and have a knack for poor financial decision making.

Curiously, one of the main advantages of mutual fund investing is supposed to be professional money management by seasoned pros. But people have found a plethora of ways to mess up even that.

Dalbar 30 Yr Study

Unfortunately, people who buy individual stocks aren't that much better than people who buy mutual funds.

In a study conducted at the height of the dot-com frenzy, by professors Brad M. Barber and Terrance Odean, they found:

1.  Households trade common stocks frequently. The average household turns over more than 75 percent of its common stock portfolio annually.

2.  Trading costs are high. The average round-trip trade in excess of $1,000 costs three percent in commissions and one percent in bid-ask spread.

3.  Households tilt their investments toward small, high-beta stocks (NYSEARCA:IJR). There is a less obvious tilt toward value stocks (NYSEARCA:VTV).

I recently caught up with Terrance Odean, who continues his groundbreaking research about investors' habits at the University of California at Berkeley. In my video interview with Odean , he talks about a 14-year study of Asian daytraders and how it relates to individual investors in the U.S. and elsewhere.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Bonds , stocks

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